Hester Peirce is a senior research fellow at the Mercatus Center and served as a senior counsel on the minority staff of the Senate Banking Committee during the drafting of Dodd-Frank.
The fiscal cliff deal painfully hammered out in the waning hours of 2012 likely foreshadows the battles yet to come this year over the country's fundamental mismatch between revenue and spending. But these fiscal fights are not the only reason 2013 promises to be interesting. The new year will bring with it an intense period of Dodd-Frank rulemaking and the implementation of rules recently put in place.
As Dodd-Frank comes to life, its harmful effects will come into plain view. Solutions crafted without a clear focus on the problems that need fixing can create new, even more severe consequences. These issues are described in detail in an upcoming book entitled Dodd Frank: What it Does and Why It's Flawed, due out tomorrow by the Mercatus Center at George Mason University. A quick overview of the law's shortcomings is a stark reminder of the dangers of legislating in haste:
- Codifies Too-Big-to-Fail. Rather than eliminating the market's expectation that certain big financial firms are too big to fail, Dodd-Frank creates an explicit set of too-big-to-fail entities—those selected by the Financial Stability Oversight Council for special regulation by the Fed.
- Threatens Small Businesses. Dodd-Frank's complex web of regulations favors large financial firms that can afford the lawyers to analyze them. New requirements will be disproportionately costly for small banks and small credit rating agencies. Dodd-Frank's complex derivatives rules will further concentrate an already concentrated industry.
- Hurts Retail Investors. Dodd-Frank gives the Securities and Exchange Commission a new set of responsibilities that distracts it from its core mission. New rules impose costs on nonfinancial companies that will be passed on to investors and consumers. Commission resources will be diverted to protecting the wealthiest investors.
- Consumer "Protections" Harm Consumers. The consumer financial products regulator established by Dodd-Frank, rather than helping consumers, threatens to raise the prices consumers pay and limit the products, services, and providers available to help them achieve their financial objectives. Various rules, such as price controls on banks' debit charge fees to merchants, are likely to increase bank fees for consumers and drive low-income customers away from basic banking services.
- Sows the Seeds for the Next Financial Crisis. Dodd-Frank forces complex derivatives into clearinghouses. These entities will be large, difficult to manage safely, and very deeply connected with the rest of the financial markets. If one of these clearinghouses runs into trouble, the economic ramifications could be massive, which means the government will be tempted to engineer a bailout.
- Creates New Unaccountable Bureaucracies. Dodd-Frank establishes several new bureaucracies, including consumer protection, data management, and stability oversight agencies that operate with limited transparency and little accountability to the American people.
- More Power for Failed Regulators. Despite their past regulatory failures, Dodd-Frank gives the Securities and Exchange Commission and the Fed broad new regulatory powers.
- Unchecked Government Power to Seize Firms. Dodd-Frank allows the government to sidestep bankruptcy and instead seize and liquidate companies. Vague criteria define which companies may be seized, and there is limited judicial oversight of the whole process. The Federal Deposit Insurance Corporation might use the process to prop up failing firms and to favor particular creditors.
- Interferes With Basic Market Functions. The Volcker Rule, which prohibits banks from engaging in proprietary trading and limits their investments in hedge funds and other private funds, is proving to be difficult to implement. It will be more difficult to comply with and will interfere with the functioning of the market.
- Replaces Market Monitoring with Regulatory Monitoring. Dodd-Frank relies on the hope that regulators that failed before and during the last crisis will be able to spot problems in the future. For example, Dodd-Frank gives broad new systemic risk oversight responsibilities to the Fed and the Financial Stability Oversight Council. It also raises the deposit insurance cap to $250,000, which will discourage large depositors from monitoring banks and correspondingly increase the likelihood of regulatory intervention.
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