The Bad Financial Reform Bill

More assessment from the WSJ on this Financial Reform Bill....It's really bad law!


Triumph of the Regulators
The Dodd-Frank financial reform bill doubles down on the same system that failed

President Obama hailed the financial bill that House-Senate negotiators finally vouchsafed at 5:40 a.m. Friday, and no wonder. The bill represents the triumph of the very regulators and Congressmen who did so much to foment the financial panic, giving them vast new discretion over every corner of American financial markets.

Chris Dodd and Barney Frank, those Fannie Mae cheerleaders, played the largest role in writing the bill. Congressman Paul Kanjorski even offered a motion to memorialize it as the Dodd-Frank Act. It's as if Tony Hayward of BP were allowed to write new rules on deep water drilling.

The Federal Reserve, which promoted the housing mania and failed utterly in its core mission of monitoring Citigroup, will now have more power to regulate more financial institutions and more ability to dictate the allocation of credit.

And the SEC, which created the credit-ratings oligopoly and missed Bernie Madoff, will get new powers to decide how easy it should be for union pension funds to get their candidates on corporate proxy ballots.

Oh, and Fannie Mae and Freddie Mac? They aren't touched at all, even as they continue to lose billions of taxpayer dollars each quarter.

In other words, our Washington rulers have taken 2,000 or so pages to double and triple down on the old system that failed.

Perhaps the most striking irony is that even in 2,000 pages Congress isn't precisely defining new bank powers. That task will be left to the regulators in the coming weeks and months, a reality that some in the media are finally figuring out. They are now reporting, with notable alarm, that this means bank lobbyists will be able to influence those rules behind the scenes. What did reporters think would happen in a system built not around clear parameters of what institutions can and cannot do, but instead entirely on regulator discretion?

Take the Volcker Rule, which proscribes banks that accept insured deposits from engaging in the riskiest kinds of trading. This makes sense in theory but the rule's execution will depend on how regulators define and enforce it. It's hardly reassuring when the Davis Polk & Wardwell law firm has to write a seven-page memo, as it did on Friday, explaining how this rule-making will proceed. The Volcker Rule may work in restraining excessive risk-taking. Or it may merely drive that risk-taking into other institutions that will attract the best and brightest drawn to the higher profits such trading can gain.

Consider as well the doctrine of "too big to fail," which FDIC Chair Sheila Bair says this bill will end. It is true that, thanks mainly to Ms. Bair and Alabama Republican Richard Shelby, Dodd-Frank puts more constraints on bailouts than Treasury Secretary Tim Geithner or Fed Chairman Ben Bernanke wanted.

But the Fed (with the consent of the Treasury Secretary) can still use its emergency lending authority to rescue a firm as long as it also provides loans to similar institutions at the same time. The bill also gives access to the Fed discount window to the new clearinghouses that are supposed to handle most derivatives trades. So the same exchanges that are supposed to reduce the riskiness of derivatives trades will know the feds will bail them out if they get into trouble.

Meanwhile, the FDIC Chairman will be free to choose which creditors to rescue and which to punish when a company goes into "resolution," even discriminating among creditors who bought the same bond issue. Expect union pension funds to fare better than other creditors when the feds roll up a bank in the future.

In the same way, Congress also added a last-minute, dead-of-night $19 billion tax on some financial institutions to pay for the implementation of these vast new regulatory powers. Who will pay this tax? Whoever the council of regulators decides should pay. The tax can hit any financial firm with more than $50 billion in assets (excluding banks that have deposit insurance, and Fannie and Freddie or any government-sponsored enterprise) and hedge funds that manage more than $10 billion.

This will take $19 billion out of financial firms that supply capital to growing companies, and it will punish precisely the firms that have attracted the most capital because of their better-than-average performance. This is only one of many new ways that Dodd-Frank will reduce the supply and raise the cost of credit across the economy. Think of how last year's limits on credit card fees have already reduced the supply of consumer credit and are leading to the end of free checking for all but wealthy bank customers.

We could go on, but perhaps the best summary is to hail Dodd-Frank as the crowning achievement of the Obama "reform" method. In the name of responding to a crisis, the bill greatly increases the power of politicians and regulators without addressing the real causes of that crisis. It makes credit more expensive and punishes business without reducing the chances of a future panic or bailouts.

The only certain result is that when the next mania and panic arrive, and they will, Congress and the regulators will claim they were all someone else's fault.