Happy Birthday Frank-Dodd; Here's to NOT Many More

Lost amid the news this past week with headlines filled with a nutcake on the rampage in Colorado, Bain Capital, and Mitt Romney’s tax returns is the fact that the Frank-Dodd Wall Street Reform law celebrated its second birthday. Many rightfully believe that the Affordable Care Act (a/k/a Obamacare) may be one of the most ill-conceived laws in history, and it certainly ranks up there. However, an even more ill-conceived law, if that is possible, is the Frank-Dodd financial reform law which Obama signed in 2010. This 2000+ page monstrosity is the poster boy for “crisis legislation.” Based upon no reasoned Congressional analysis and devoid of thoughtful consideration, it is a typical knee-jerk piece of legislation meant to assuage the fears of the masses. It is a “feel good” law with serious unintended consequences. Most importantly, it illustrates a gross Congressional misdiagnosis of the cause of the 2008 financial meltdown that ushered in a recession of which we are still feeling the effects. One glaring example is it avoidance of addressing the issues of reforming Fannie Mae and Freddie Mac- two entities that hold 40% of all mortgages in the United States- and of the underlying law- the Community Reinvestment Act- which created the atmosphere that led directly to the financial collapse.

Without going into all the gory details and reliving recent history, it was the housing market collapse which was fed by dubious loans to people undeserving of loans in the first place and the exotic financial instruments banks devised to increase profits and minimize risk. It is also ironic that as early as 2003, George W. Bush’s Treasury Department was calling for fundamental reforms in the mortgage market through Fannie Mae and Freddie Mac. It is equally ironic that the New York Times of all newspapers openly endorsed Bush’s call for reform. But, the biggest irony is that those reforms were rebuffed by two actors whose name now adorns the “solution-” Barney Frank and Christopher Dodd.

In its haste to push through legislation, Congress not only misdiagnosed the cause of the problem, they passed a law with unintended consequences. Just looking at the cost of compliance with many of the provisions, the costs are staggering. The Financial Services Roundtable estimates that to implement just three regulations will require over 862,000 man-hours at a cost of $84.375 million. Overall, some analysis puts the cost of compliance at over 10 million man-hours of work each year. Community banks, which were largely immune to the ill-effects of the banking crisis because they know the community and are smaller, will also be affected. There is even the belief that many community banks are currently actively restraining growth to stay below the $10 billion threshold to avoid the more onerous compliance issues.

The fact is that by making unelected bureaucrats and regulators the saviors of society from itself, no one knows the real cost of compliance. And, the way the law is written, apparently Obama and company want to keep it that way. Obviously, businesses cannot function, operate and plan in an atmosphere of uncertainty. As of July 2, 2012, more than 63% of the deadlines for regulation enactment have been missed. This cloud of uncertainty has created stagnation since many businesses do not know the demands under which they will be placed. This caution, naturally as any business-owner will tell you, creates a tightening of credit, likely higher fees, fewer service innovation and a decrease in jobs created.

In June of this year, Moody’s lowered the rating of the top 15 banks in the US. Why? Because the unknown compliance costs of Frank-Dodd make it difficult to accurately evaluate bottom lines. Moody ratings are one thing, but this also affects the consumer. For example, in 2009, close to 96% of all banks offered some form of free checking to its customers. In less than two years, that number has declined to 34.6%. In its effort to minimize systemic risk to the banking system, this law has instead created a race to the bottom when it comes to risk. A capitalist system needs some degree of risk. By playing the savior of society, Frank-Dodd is akin to the school that hands out awards to all participants whether they win or lose.

It is appalling that greater than 50% of the “mandates” in this law use the word “may” or “as deem necessary” when applied to the regulators. These are rather vague terms. Simply using the word “may” creates uncertainty. The most heinous part of the law is the consumer protection board set up within the Federal Reserve. Its budget is a proscribed proportion of the Federal Reserve’s. By doing this, Congress deliberately moved the Board from either Congressional or Executive oversight other than through the appointment process. That was the real battle over Elizabeth Warren as Charirwoman of the Board. Also, its regulations would not be subject to independent review before implementation. Hence, in the name of consumer protection, a dictatorial board that “may” issue directives and regulations “as they deem necessary” is a huge grant of power to unelected officials. It should also be noted that more than a dozen of its employees make $225,000 a year.

The asset liquidation aspects of the law are equally troubling. I always thought the government had an asset liquidation system in effect called federal bankruptcy law. Instead, that is now the task of federal regulators with little or no judicial oversight. At some point, this aspect of the law is going to run into the Fifth Amendment’s Takings Clause.

Instituting the Volcker rule is also problematic and is supposed to be fully implemented in 2014. Yet, regulators are nowhere near finalizing the regulations. This rule would limit how much a bank can invest of its own funds. This has the potential to lower bank earnings which will simply increase consumer fees. Additionally, Congress was very vague on the particulars leaving an ill-equipped regulatory apparatus to work out those particulars. Is that any way to legislate?

Perhaps the biggest mistake was the so-called Durbin Amendment, named after Senator Dick Durbin (D-IL). However, one has to consider the fact that Durbin was, after all, Obama’s mentor in the Senate. This rule set a limit on the transaction fee charged to businesses for credit and debit card use at those businesses. Originally, it was an average of 44 cents and explains why many businesses have signs noting a minimum purchase for card use. Realizing they were not going to win and charging that Congress was underestimating the costs to banks, they argued for a 27 cent fee. Instead, they got 12 cents. This is expected to cost banks somewhere between $32 and $39 billion. I am not one to cry over bank profits, but the fact is they will make up that money somewhere else and that “somewhere” is the form of higher interest rates on those cards, annual fees where none existed before, and a decrease in consumer options despite the creditworthiness of the individual. Even more onerous is the Board can adjust these fees up or down “as they deem necessary.”

Frank-Dodd is an ill-conceived law from the start. In many respects, it is reactive, not proactive. It does not even address the problems that caused the financial meltdown and put the entire financial sector at risk. It is, at best, an ad hoc system that, at worst, places too much power in the hands of regulators and unelected officials with no Congressional or Presidential oversight. As is often the case with Congress, they have handed over the reigns of legislation to bureaucrats whose task it is to save us from ourselves. There is not even any provisions for a cost/benefit analysis of any regulation they may enact.

Businesses work best in an atmosphere of certainty. They need certainty when it comes to taxes and health care benefits and the like so that they can make informed decisions that lead to capital improvements. expansion, and hiring. Is it any wonder the economy is stagnant today? Mitt Romney, one suspects, knows this at its core. Obama and company are ignorant of this as his recent off-the-cuff remarks prove, he simply does not understand how a capitalist system works and functions.