In the last issue, Part One of "How's the Government Progressing" looked at some of the broader root causes of our stalling recovery - the bank bailouts, corruption, instability in the housing market and our cumbersome bureaucratic process. Part 2 takes a closer look at the Dodd-Frank bill, the intent vs. the current reality and the rising Cost of Regulation to society.
The magnitude of the financial crisis of 2008 was truly shocking, but the fact that it caught so many off guard was even more unbelievable. Despite the fact that most people felt that the government was partly responsible, they still looked to it expectantly for the cure. When the announcement was made in June of 2009 of Obama's proposal for Financial Regulations Reform, it was evident that the Obama Administration wanted to communicate the message that they were taking charge of the crisis in a big way. Besides increasing the authority of the Federal Reserve, which many felt was like putting the fox in charge of the hen-house; it called for the establishment of the CFPA (Consumer Financial Protection Agency) and promised to reform everything along the financial path from Wall Street to Main Street. A year into the process, it is clear that the Reform "assignment" was much easier said than done, and with latitude given for it being far from fully implemented, it is still important to examine whether the reform has been effective so far.
The Dodd-Frank Act (H.R. 4173)
While it may seem ironic that Chris Dodd and Barney Frank, the two men most responsible for the collapse of the housing industry, were the writers of the bill, perhaps the argument can be made, that it's fitting that they be put in charge of fixing the situation. When the Wall Street Reform and Consumer Protection Act, otherwise known as the Dodd-Frank Act, was signed into law on July 21, 2010, it was hailed as the most massive financial restructuring since the Great Depression. What that meant exactly, was unclear, as the details had yet to be worked out, none-the less, during that time of fear and uncertainty it was received with great optimism.
From the start,Dodd-Frankwas not a straightforward attempt to target our problems, correct any flaws in the current regulatory structure and create better system for enforcement. It was the "Big Government" proponents dream, and the Obama Administration and the authors wanted it to be grand in scale. At the time, most reports referred to it as "sweeping" in nature, and to be sure, it set the framework for comprehensive changes that would potentially impact all financial regulatory agencies at the Federal level, and the entire financial services industry nationwide. The broadest goals of the bill were meant to implement changes that would help the country maintain financial stability and avoid another crisis, such as:
- requiring a higher level of accountability and transparency of financial institutions and Wall Street,
- ending the to "too big to fail" trap that required massive bailouts by taxpayers; and
- Creating a new agency, the CFPB (Consumer Financial Protection Board) to provide better protection for consumers and investors.
A multitude of more specific goals dealt with such things as:
- Mortgage Industry reform to put an end to predatory lending
- Emergency Mortgage relief to unemployed homeowners;
- Developing an orderly process for institutional liquidation as needed for those deemed to be of systemic risk;
- Strengthening the enforcement component of regulations already on the books;
- Providing new oversight of Credit Rating Agencies which failed to anticipate the crisis;
- Financial Stability Oversight Council - designed to protect and prevent systemic risk;
and the list goes on, calling for advisory boards, new councils, numerous studies, and the creation of over 500 new rules and regulations.
While the goals sound reasonable in their logic and worthy in their intent, the devil is always in the details and the legislation, as it continues to evolve, is quite another story. While impressive in scope, scanning the 2300 page bill leaves one wondering if the authors haven't bitten off more than this country's taxpayers can ever chew.
First Year Status
To date most of the details of Dodd-Frank are not yet even close to being worked out, and few really have a clear understanding of what it was meant to do,which makes it difficult toanticipate exactly what the affects will be. It is estimated that only about 38 of the 500 new financial regulations even having been written so far. The following graphic published in Business Insider on July 21st provides a funny, yet sobering picture of what is left to do.
Click on the "graphic" link above the chart for a closer look at the flow chart detail.
And, the Dodd-Frank website itself, designed to keep the public abreast of changes as they develop, is pretty hard to make sense of.
To be fair, since there is such a long way to go before Dodd-Frank is fully defined and implemented, only time will tell whether it has improved the system to any major degree. On the heels of the great stock market rally following government bailouts and money printing by the FED, Wall Street bashing rhetoric continues to play well to the public, and a year after its signing, what the bill stands for is generally viewed favorably by the public. Yet, the sheer complexity of the undertaking has made progress painstakingly slow, and thus far, it seems as though in many areas, the bill may have had the opposite effect of that which was intended. Critics have attacked Dodd-Frank as a "jobs killer" and a sham that has made TBTF banks bigger, "risky incentives riskier" and a bad economy worse. To make matters worse, at a time when deficits are running amok and more than half the country believes that "Big Government" got us into this fix, the bill has become so politically charged, that implementation may be bogged down for some time to come. Partisan bickering has rivaled that over Obamacare, and more than 2 dozen bills to retract parts of Dodd-Frank are currently pending in Congress.
Click on the 'sham' link above to see funny skit aired on Jon Stewart
Even the president of the Kansas City Federal Reserve, Tom Hoenig, has criticized Dodd-Frank severely for making the financial system less safe. An outspoken critic of the "too big to fail" (TBTF) problem, Hoenig, in a June interview with the American Banker, points out that by now defining what a "systemically important financial institution" is, the bill has in effect, given the largest banks license to be "too big to fail". Indeed they are 20% larger today than they were in 2008.
Loss of Community Banks
A big concern over Dodd-Frank is the creation of legislation that undermines small banks. At the peak of the crisis when large banks had frozen lending, it was the Community Banks that kept the economy moving forward. Running as the Community Bank candidate, Newt Gingrich has been one of the more outspoken critics of Dodd-Frank. Gingrich says that the bill insures TBTF by rigging the deck against small banks. Gingrich states that "When you get to huge bureaucratic institutions, [...], you have no capacity to provide local leadership anymore." He says, "You would ideally like to have a policy that maximized the growth of small banks that were small enough that they could fail without risk to the general economy." He is also concerned that the Financial Stability Oversight Council could lead to many problems as it is currently designed. "When you have a handful of people that have the power to intervene in institutions that have billions of dollars, you have an invitation to corruption on a grand scale". Generally Gingrich criticized the bill for trying to micromanage the financial system, when all that was needed was to enforce our existing regulations. We had failures because the existing agencies just didn't do their job.
CFPB
The keystone of Dodd-Frank was the formation of the CFPB (Consumer Financial Protection Bureau), which consolidated financial oversight currently spread over 7 other agencies into one. It has charge of regulating all consumer financial products and its 2 main goals are:
1) To create fairness and transparency in financial products and services markets
2) To make credit products easy to read and compare for consumers
Controversial from the start for its leadership structure and the lack of accountability, it has an education component, a consumer response center for complaints, and an enforcement arm, and there is no doubt that the Agency will have very broad and weighty authority over lending practices in the future. While the authority transferred to it is the same in many respects as that of the previous agencies, what it different, is the focus. The previous agencies monitored a range of things, while the focus of this one will be solely on consumer protection issues.
Of deep concern to many, was that the agency was initially set up to operate with limited congressional oversight, with unprecedented power concentrated, for the most part, in one single director. This has been a major stumbling block in getting bipartisan support. Republican leadership has refused to support any single nominee, demanding instead that the directorship be replaced by a board. It has also pressed hard for Agency funding to be removed from under the Federal Reserve and to be subject to the appropriations process for greater accountability.
Although it has been operational for several months, the Agency officially opened its doors on July 21st and it is already reaching out to consumers in a big way. Under its purview, there are numerous studies that will be undertaken on a variety of things such as Reverse Mortgages for seniors. Until these happen and clear guidelines are in place uncertainty will remain with more questions surfacing than answers. Some of the questions that are already emerging relate to whether protecting consumers will end up harming them in ways that had not been anticipated? Will attempts at lowering credit card interest rates, curbing overdraft fees and limiting swipe fees actually hinder access to credit? By cutting off sources of funds for banks, will the banks start cutting free services? JP Morgan Chase, for example has already eliminated its free checking accounts, and most large banks are beginning to impose annual credit card fees. Other casualties may be ATM fee reimbursement; cash back rewards programs, limited mortgage options and restrictions on quick sources of cash such as Pay Day loans. The question one has to ask at this point is, for the huge cost of implementing this new agency, are the consumers really ahead, or have we just shuffled responsibilities around between agencies?
Rising Cost of Regulation
Most would agree that meaningful regulation is necessary to discourage corruption and create a fair environment for businesses to operate in smoothly and efficiently, while still providing the free market economy that allows them to thrive. The United States, the most successful economy in history, is currently drowning in a morass of laws, regulations and bureaucracy, the preponderance of which has become so complex that they are often impossible to understand much less follow. The knee jerk reaction to problem solving in any new crisis is for congress to write more laws and form more agencies to enforce them. The hundreds of regulatory agencies that now exists is a bureaucratic nightmare with overlapping jurisdictions and conflicting agendas that often leave citizens in a position wherein complying with one violates another. The overall out-of-pocket cost of regulation to businesses, as estimated by a recent SBA study, was $1.75 trillion. This cost is ultimately paid by consumers. While the broader economy has grown an anemic 5% since 2008, regulatory Agency budgets have grown 16%, to $54 billion. Agency employment has outpaced that in private and other public sectors rising 13%, as compared to a drop in private sector employment by 5.6%. A recent Heritage Foundation Study revealed that new rules and regulations since 2008 alone, have cost the private sector more than $40 billion. The SBA study also found that there are costs of efficiency with company size with small businesses are spending 36% more per employee to comply with new regulations than larger companies. It is not hard to understand how this would negatively impact hiring in the private sector.
The loss of jobs due to the regulatory burden in one of the hidden costs of regulations, but there are other hidden costs associated with the regulatory process as well, including agency costs, additional employment costs in the loss of jobs that end up in other states or countries, and the loss of economic output. Among the hidden costs of regulation is the loss from corruption. Since most corruption in the public sector can be traced to government intervention, the bigger the government is the more corrupt it usually is. Within the regulatory environment, officials can, and do, harass or delay, or selectively impose costs to impact a firm's competitive position. The temptation for extortion and bribery are great whenever time costs money and someone will always pay to avoid delay. In addition, contracts involving corruption may not end up with the most efficient firm. Although difficult to quantify from a cost standpoint, typical arenas that are ripe for corruption are trade restrictions, subsidies, price controls, and virtually any industry or arena that is regulated. The more obvious results are inefficiencies, inequities, delays due to red tape and ultimately slower economic growth.
While the CFPB's website is supposed to include a Consumer Education component, to date it is not much more than a PR site for Dodd-Frank. As time goes by, it will no doubt include all the information that is currently available on the web, about scams and complaints, and maybe more. Odds are that they will not provide information on the hidden costs to consumers of the regulatory process itself, at multiple levels.
Conclusion
Consumer Protection is an important task that few would argue is best handled at the Federal level. And, the idea of consolidating Consumer related issues into one Agency is a good one in theory, but only if it operates more efficiently than spreading the job over multiple agencies with conflicting agendas. There is no way to conclude, however, that efficiency was in any way considered during the drafting of Dodd-Frank. Instead of reinstating programs that have worked in the past, like the Glass-Steagal Act, which separated commercial from investment banking, the authors opted to reinvent the wheel. This approach is flawed. It is not logical to believe that a highly politicized committee process of arbitrary decision-making and irrational compromises would result in sound policy. In addition, the attempt to standardize practices that are ever changing from influences of new developments, competition and risk management only begets more regulation and doesn't benefit anyone. It is not only puts a stranglehold on business, it is disrespectful of those who pay the bill. It is exactly the mentality that has brought us giant Federal deficits.
The regulatory burden on our economy is substantial and it has made it impossible for us to compete in world markets. In a perfect free market economy, this tool should be used with discretionand not to solve every one of the unending number of problems that can arise in the business world. Abuses by Regulators are every bit as damaging as those in private industry and people's lives are ruined daily; the difference is that in the public sector there is less accountability.
The failures we witnessed in 2008, were many fold, but mostly relating to failures by existing Agencies to do their job, and by the failure of Congress to require that banks uphold proven lending standards. Expanding bureaucracy on the backs of taxpayers is irresponsible, and to do so during a major recession is proving to be disastrous. As well intended as Dodd-Frank is, it only makes a system already over-burdened by regulation worse. It is pretty clear at this point, that the sheer complexity of the bill along with the controversy it has stimulated has done more harm than good simply by prolonging and increasing the level of uncertainly in the business world, hindering the ability, particularly for small businesses, to hire and grow. Even if it ultimately does some good, couldn't that have been accomplished in a more cost efficient way?
More than a little unsettling after all is said and done is Chris Dodd's own admission that this bill will not prevent the next economic crisis. "It is not a perfect bill, I will be the first to admit that," Dodd said. "It will take the next economic crisis, as certainly it will come, to determine whether or not the provisions of this bill will actually provide this generation or the next generation of regulators with the tools necessary to minimize the effects of that crisis."
