Five Years Later, Dodd-Frank Is Still a Monstrosity

In his op-ed in today’s Wall Street Journal, Phil Gramm does a nice job summarizing what a disaster Dodd-Frank has turned out to be. I’ll add (or amplify) with the following points:

1. A catastrophe complexity. Of the 400 or so rules Dodd-Frank mandated just 60% have been written and finalized. Twenty percent haven’t even been drafted yet! It’s been fully five years since this major piece of legislation has been passed, and yet the law is so dense and complex that it’s nowhere near being fully implemented. How can anyone say that this is conscientious governance? For the past five years, and for many years still to come, the financial services industry has operated in a regulatory no-man’s-land, knowing that important rules are set to be rolled out but not knowing what those rules will actually say. This isn’t the rule of law. It’s the rule of hunch and guesswork. You may say that evil bankers had it coming. But the effect has been to crimp the efficient creation of credit for investment and spending. Everyone has been hurt.

2. Stress-test idiocy. If the credit crunch taught us anything, it’s that in moments of crisis, financial what-if models, whether they’re run by rating agencies, banks’ risk management units, or financial regulators, fail catastrophically. They just don’t work; you simply can’t quantify what a chaotic future will look like. So what has the government done in response? Mandate more financial models! I hate to burst policymakers’ bubble, but the stress tests they’re forcing the big banks to conduct every year won’t do a thing to mitigate the sheer panic investors will feel during the next financial crisis. No matter how sound a stress test says a bank’s balance sheet will look when the crisis happens, when the crisis actually occurs, no one will believe it. Pretending otherwise beforehand is sheer self-delusion.

3. The Durbin amendment charade. The Durbin amendment was supposed to save consumers’ billions by capping debit-card interchange fees banks charged retailers, remember? In fact—and to no one’s surprise except perhaps Dick Durbin—it was retailers, not consumers, who got the windfall, since retailers naturally failed to pass on their savings to consumers, in the form of lower prices. Worse, banks did what they could to make up for their lost fee income by concocting new customer fees. So not only were costumers not helped by the Durbin amendment, they were actually hurt by it. Wonderful! This of course is utterly predictable to anyone who understands how the world really works.

4. The CFPB monstrosity. The Consumer Finance Protection Bureau, just to remind you, is run by a single individual (rather than a bi-partisan board, as other regulators operate) who can’t be fired by anyone, even the president. His agency is not answerable to Congress in any meaningful way since, it is funded directly via revenues from the Federal Reserve rather than annual Congressional appropriation. Which is to say, the agency can largely do whatever it wants, whenever it wants to, and no one can stop it. The CFPB is an affront to representative democracy. But don’t worry. The CFPB is supposed to protect you. Good luck with that.

5. Ugh, the Volcker rule. The Volcker rule, recall, prohibits federally insured depositaries from engaging in proprietary trading. The logic behind the rule is . . . well, I can’t say what the logic behind the rule is, since proprietary trading by banks had nothing to do with causing the credit crunch. Now that I think of it, if during the housing boom firms like Bear Stearns, Countrywide, and Washington Mutual had spent more time and effort on their proprietary trading businesses and less time and effort writing subprime loans, they’d all still be in business and the credit crunch never would have happened. But that’s simple logic, and we’re talking about Dodd-Frank here, so it’s irrelevant. Anyway, big banks can’t engage in proprietary trading anymore, which means, as a practical matter, they’ve largely exited the market-making business. Thus Dodd-Frank has unilaterally created the next potential big risk the financial system faces: paralyzing illiquidity and chaos in the fixed-income markets if, as, and when the Federal Reserve raises interest rates. Thanks, Chris and Barney!

6. The living-will charade. A “living will” is supposed to be an instruction book of sorts that lays out how a financial institution will liquidate itself in an orderly manner should it run into financial trouble during a crisis. Which is to say, it’s a useless piece of paper. Nothing is orderly during a crisis. That’s why it’s called a crisis! So the asset buyers the living will’s writers imagine will be standing by will actually be nowhere to be found. The stable, core businesses the authors assume will fund the enterprise it winds down may or may not be stable. Bids will not be forthcoming, phone calls will not be returned, and regulators will not be acting rationally. The world that a living will presupposes is pure fantasy. The documents will turn out to be useless.

Other than that, the Dodd-Frank bill is a monument to Congress’s legislative wisdom. The law is now five years old. It is not an anniversary to celebrate. As Richard Shelby, head of the Senate Banking Committee, said this week, the law is a “nightmare.”

What do you think? Let me know!