When the Dodd-Frank Act was signed in the summer of 2010, I thought it would be impossible to find a worse piece of legislation in modern history. Looking back, I now believe that this judgment, dismal as it was, actually failed to capture how really bad this legislation was.
By putting this bill into law the government has:
The government has effectively nationalized the banks. The regulations that have sprung from the Dodd-Frank Act demand the following:
- Banks be penalized if they get too big.
- Banks buy government-backed securities and Federal Reserve deposits (which are used for Treasury purchases) to meet liquidity requirements.
- Banks make acceptable loans or be fined or penalized for making loans the government does not like.
- Banks avoid borrowing in short-term money markets which are perceived to have systemic risk and raise funds in long-term equity markets, instead.
In so doing, the government has taken control of the bulk of money flows in the United States economy. One does not think of capitalism as a system whereby a government sets the price of funds; determines the amount of funds that are to be in the system; and then dictates where a large portion of those funds go through the banking system.
This is not free-market capitalism.
By over-regulating the banking system, the regulators have incented the expansion of the non-bank financial system and dramatically increased the likelihood of a bigger financial failure than was experienced in 2008, at some future point.
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Private-equity firms, master limited partnerships, REITs, marketplace lenders, mortgage bankers, auto finance companies, commercial finance companies, credit card companies, and others down to payday loan companies, pawn shops, and the mafia have been given new opportunities by Dodd-Frank.
There are a few positive effects of such a system: Banks are less dominating and the private sector develops a number of attractive financing alternatives. And, by establishing companies that have no call on government funds, loan underwriting improves and the system eliminates risk.
My problem is history. The United States tried operating such a system from its founding up to the 1930s. The result was constant financial panics and failures.
Explaining the collapses is simple. The economy is cyclical. In the down periods, money flees from high-risk pursuits to low-risk investments. Monoline financial companies, which are what these new entities are, tend to be perceived as high-risk pursuits. Unfortunately, these companies lose access to funds in bad times and many go bankrupt even if they are well capitalized banks.
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It was only due to total frustration with the constant collapses and company failures that approximately 100 years ago the nation began setting up a series of triggers and fail-safe protections to ameliorate the harm during a recession. And, it worked. There has not been a depression in this country since 1940.
Dodd-Frank rips away this system that took 100 years to put in place. It makes a new demand. That demand is that banks fail when they get in trouble. It perpetuates the theory that these new private enterprises fail when they lose access to funding.
The cost of the new regulations has resulted in higher prices for virtually every banking service. Imagine the cost of a banking system that must pay for tens of thousands of people involved in regulation. The cost of this structure is passed along to the users of the system. Free checking is a memory.
The Durbin Amendment is another example of how Dodd-Frank drives up banking costs. It drove free checking out of the banking system by price-fixing debit-card services. There are multiple "Durbins" in Dodd-Frank. Bank branches are being closed across the country.
Banks now hold more cash than single family mortgages. And if current trends continue, there will soon be more Treasury securities in the banks than home-equity loans.
If you believe in capitalism; a safe and sound total financial system; free flow of low-cost funds to the private and not the public sector; and a legal system based on checks and balances; you cannot believe that Dodd-Frank has done anything good for this country.
Commentary by Richard X. Bove, an equity research analyst at Rafferty Capital Markets and the author of "Guardians of Prosperity: Why America Needs Big Banks" (2013).