Killing the patient with Dodd-Frank

After a meteoric rise over the past year, the Chinese stock market finally tumbled back to earth, dropping over 22 percent in just four days and wiping out some $1 trillion of value. Bureaucrats in China have cobbled together various fixes, like slashing interest rates and flooding the banking system with cash but as of this writing they have had little effect. That the same government officials who planned China’s overheating economy through Five-Year Plans and ludicrously speculative development plays are struggling now to right the ship is little surprise.

Our own bureaucrats are toiling away too, but on the final sets of regulations mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act. Passed in 2010 in the wake of the financial meltdown, the law is like most things liberals come up with: well-intentioned but poorly executed and riddled with toxic interactions. The fact that it has taken this long for Washington pinheads to figure out how to enforce it speaks to how poorly designed this law is despite its baffling length and complexity.

A reasonable level of oversight was warranted after reckless bankers sent the global economy into a tailspin. But Dodd-Frank was erected as a punitive thicket of red tape at a time when bankers were vilified as bloodsucking plutocrats and the public wanted their heads. It’s time to calm down and remember that banks play a vital role in our economy and shouldn’t have to spend half their time satisfying the bureaucrats breathing down their necks.

The law is crippled by a fundamental paradox: to reduce the risk of “too big to fail” financial institutions tanking the economy, it has helped big banks get bigger by swallowing up the little guys who don’t have the resources to fulfill all of the monitoring requirements and still turn a profit. Small community banks and credit unions are the lifeblood of small businesses and local entrepreneurs, but by Washington’s own admission we are now losing one every day. While this consolidation was part of an overall trend, researchers at the Fed and Harvard have found Dodd-Frank contributed.

Although the big banks have found it much easier to buy up shuttered community banks, they’ve got problems of their own, too. The “Volcker Rule,” named for former Fed Chair Paul Volcker, prohibits banks from engaging in proprietary trading. Coupled with enhanced capital requirements that require banks to sit on more cash, the rule has pushed these institutions out of bond and equity markets and restricted businesses’ access to cash. The corporate bond market has languished despite surging demand, and many economists cite the lack of liquidity in that sector as a potential source of another financial crisis. Since banks have been forced to hoard more cash and get out of bond markets, large companies have started loading their books with more and more cash instead of spending it on R&D and expansion, essentially acting as their own bankers out of fear that in a crisis they won’t be able to find credit. Small businesses do not have such a luxury.

Our banking system needed to be reined in after it became clear that it was taking huge risks. Lehman Brothers had loaded up on risky assets that flew in the face of its own risk management policies, and their catastrophic failure kicked off a global financial meltdown. But the reams of hazy regulations we dumped on them in response just might trigger the next one. Dodd-Frank makes the oft maligned “too big to fail” banks bigger, edges out small banks, enshrines taxpayer-funded bailouts in law, and restricts access to credit.

Certain liquidity requirements are necessary to ensure banks don’t play fast and loose with massive amounts of money. But taken together, the gnarled circuitry of this sprawling law does what overly complex laws often do: create unintended problems and clog up the machinery. We need a more modest and more market-oriented set of reforms, not this reactionary girdle of red tape.

James Queen

James Queen

James Queen

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