Inside Financial Services

More Perverse Effects of Dodd-Frank

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This just in from the Dept. of Unintended Consequences:

Guidelines aimed at strengthening lending standards are shifting the market for high-yield credit to less-supervised loan funds, raising alarm this week from the Financial Stability Oversight Council. Because the funds don’t have depositors, some of their money comes from Wall Street banks, leaving systemically important institutions exposed to risks regulators hoped to avoid. [Emph. added]

So as regulators clamp down on leveraged lending by banks, that lending is increasingly being done outside the banking system by loan funds that are being partially funded . . . by the big banks! Who would have expected? Thus the tighter regulation of the banking system put in place in the wake financial crisis has, in this instance, at any rate, made the system less stable.

Leveraged lending isn’t the only activity that’s venturing out of the banking system, by the way. Thanks to the Volcker rule, for instance, much of the market-making activity that was once a staple for banks is more and more being done by non-bank trading shops not under the scrutiny of the toughest federal regulators. Presumably these trading houses are getting their liquidity from bank lines, as well.

The upshot: in many areas, the net effect of Dodd-Frank and other financial post-crunch financial “reforms” has been to make the overall financial system more opaque, less supervised, and needlessly complex.

This is not an improvement.

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