Tuesday, March 6, 2012

Too big not to fail

The Economist has a great article, "Too big not to fail" about the Dodd-Frank regulation. Readers of this blog will know I'm no big fan of Dodd-Frank, for example an article in Regulation, collected opeds, and collected blog posts on reform. I've made most of these points before. But to hear it from the liberal-leaning Economist, with very detailed documentation, is good news.

A few delicious quotes:

The scope and structure of Dodd-Frank are fundamentally different to those of its precursor laws, notes Jonathan Macey of Yale Law School: “Laws classically provide people with rules. Dodd-Frank is not directed at people. It is an outline directed at bureaucrats and it instructs them to make still more regulations and to create more bureaucracies.” ...

Take the transformation of 11 pages of Dodd-Frank into the so-called “Volcker rule”, .... In November four of the five federal agencies charged with enacting this rule jointly put forward a 298-page proposal which is, in the words of a banker publicly supportive of Dodd-Frank, “unintelligible any way you read it”.  It includes 383 explicit questions for firms which, if read closely, break down into 1,420 subquestions, according to Davis Polk, a law firm. 
And each subquestion presages another rule in the final version.

This is an important point. Most laws are laws. Most of the actual pages of Dodd-Frank are just directives for agencies to write the actual rules.

More importantly, it's not just explicit rules: 
But the really big issue ...Officials are being given the power to regulate more intrusively and to make arbitrary or capricious rulings. The lack of clarity which follows from the sheer complexity of the scheme will sometimes, perhaps often, provide cover for such capriciousness.

For example, the new CFPB will have latitude to determine what type of financial products can be provided to which consumers and at what cost, as well as the right to pursue institutions for acting in an “abusive” fashion (a term with no legal definition). Requirements for “living wills” that encompass hypothetical business plans have to be pored over by regulators; “stress tests” insert government assumptions deep into the decisions banks make about their capital. ... the befuddling form the act gives such ideas unintentionally opens a path to much more state interference.
That's putting it mildly.  Dodd-Frank is really not about rules at all. It just gives regulators power to decide what you do and how you do it. And it's going to be awfully hard for even the best intentioned regulator not to slide in to protecting from competition the business he's regulating (they are "systemically important" after all), or merging goals ("Nice bank you got there. If you were foreclosing a bit slower we sure could help a bit on consumer financial protection approval of that new credit card.") Or, as the Economist puts it,
Loans that might not fit into a category favoured by regulators are being trimmed or withdrawn.
..some well established banks consider themselves better able to handle the costs than smaller or newer ones, particularly those that don’t have cushy relationships with regulators. 
Mission creep:
....a provision in Dodd-Frank concerning the extraction of minerals from in and around the Congo will mean that they [manfuacturers] will have to begin filing information on their entire supply chain to the SEC. This is officially estimated to affect 1,000-5,000 companies at a cost of $71m. The US Chamber of Commerce thinks it will affect hundreds of thousands. The National Association of Manufacturers estimates it will cost $9 billion-16 billion. Conflict minerals are a disturbing issue. They were not one of the causes of the global financial crisis....

Even Dodd-Frank’s creators can bring no similar clarity to its intentions. In 2009 Mr Frank attempted to frame the new law’s goals under four heads: securitisation, compensation, liquidation and systemic risk. But in a single speech his ambitions overflowed to consumer protection and the reform of ratings agencies, too. Ambition is often welcome; but in this case it is leaving the roots of the financial crisis under-addressed—and more or less everything else in finance overwhelmed.
This point really nails the fundamental flaw of Dodd-Frank. It never really thought about what the most important core problems were, and how to fix them. Instead, it basically thinks we didn't have "enough" regulation, so proceeds to "regulate" more, and to regulate anything vaguely associated with "finance."  But, not knowing what went wrong really, it's approach is just to deputize appointed officials great power to write rules, or, more basically, direct affairs in real time. 

Regulation is not "more" or "less" to be poured about. It is "smarter" or "dumber," solving clearly understood market failures with transparent rules, or simply sending busybodies around to muck things up.

We need "smarter." Soon.


  1. This comment has been removed by the author.

  2. I like this post as well as most of your work, but I do take a slight issue with your characterization of The Economist as liberal leaning! At least in the American sense of "liberal".

    "Democracy in America" is pretty awful and could easily be written by NYT or WaPo bloggers, but I don't think the rest of the website/magazine is particularly liberal. It was of course founded in the 19th century as a classical liberal magazine in favor of free markets and free trade, and constantly makes references to its status as a "classical liberal magazine".

    Look at its endorsements:


    It has historically been very very supportive of the Tories, with the only exceptions coming when they were particularly awful (their sarcastic explanation for the Blair endorsement is "Vote Conservative"). It endorsed Reagan, Bob Dole and George W. Bush. Its non-endorsement in 1984 was based in criticism of Reagan era deficits.

  3. I just realized that could have been worded better- the point is that they're not American liberal/progressive, they're classical liberal.

    1. They used to be classical liberal, but not so much anymore. Or perhaps I'm too sensitive about stimulus....

    2. Exactly true. In 2008 they endorsed Obama, the senator with one of the very worst voting records on free-trade, subsidies and spending over McCain who courageously stood with the old Economist on politically difficult issues like farm subsidies, trade and toleration of illegal immigration. Here is the letter I sent at the time:


      "I suppose when you receive my copy of The Economist in a day or two with the words "REFUSED - RETURN TO SENDER" scrawled across the front, you'll have a vague idea of my thoughts on your recent endorsement"


      "Do the ideas of these two men count for nothing? So at this critical juncture, with one party controlling the Congress and a perfect storm of ugly populist policies darkening the horizon, what does The Economist, the 165 year bastion of freedom do? You follow the crowd and throw in with the man who represents everything that you oppose. All of the lessons of economics which you express with increasingly tepid enthusiasm in the pages of your magazine are quickly discarded for the crowd favorite and a giant smile that promises "I am whatever it is you are looking for". I suppose freedom is a great thing unless it makes you unpopular."


    3. How does having the government spend loads of money restricting the flow of labor between markets where there are striking wage differentials constitute a classically liberal economic policy?

  4. Forget about "the senator with one of the very worst voting records on free-trade, subsidies and spending..." How about just "the guy who never had a real job and yet who is expected to set economic policy to lift the nation out of a financial crisis and recession..."

    1. Everyone: Let's stay off personalities and presidential politics. There are lots of other blogs for that, even other blogs that call themselves economics blogs.

    2. John

      lets just stay with the facts.

      Gregg Smith just exposed the evil at Goldman Sachs and the other investment banks. If not Dodd Franks, how would you regulate such evil?

  5. our government is simply the best case study ever in incompetence and unintended consequences...everything they do involves a lot of both.

  6. Scott Sumner cites you in his latest post:
    He actually quotes you on the deficiencies of fiscal stimulus, but most of his post is criticizing the Fed for complacency regarding NGDP growth. I'm not sure if you've put forward an opinion, but if a Fed policy action regarded in an extra 2 percent NGDP growth (1 percent inflation, 1 percent real), would you consider that preferable to the status quo?

    1. I'm not a big fan of NGDP targets. I guess a good topic for a future post...

    2. It doesn't have to be an explicit NGDP target. Let's say they targeted a higher rate of inflation like a lot of other countries. Or they it could be in terms of long-term interest rates or quantitative easing, and as a result it just happened to be the case that both inflation and RGDP increased. Would you consider that an improvement relative to the status quo?

    3. Whoah, nobody from Chicago who was asked disagreed that bank bailouts lowered unemployment:

  7. Deputizing the crafting of future legislation is a symptom intellectual laziness that unfortunately has become pervasive in the public service lately. The last debt ceiling negotiation debacle ended up delivering a grandiose announcement that the parties had agreed... to delegate for somebody else to define how to bring down the monumental deficit that was the core of the very discussion they were trying to settle.

  8. Hey John. Love your blog!

    Look at the complexity of Dodd-Frank. It isn't as complex as Obamacare, but it is still extremely complicated. AND it ignores Fannie Mae and Freddie Mae (acting as if they had nothing to do with the financial crisis).


  9. Not only is Dodd-Frank a pig in a poke, but it only extends the unnecessary and counter productive Federal meddling begun by Sarbanes-Oxley.

    The only thing worse than a financial meltdown or malfeasance is the inevitable law to "correct" it.


Comments are welcome. Keep it short, polite, and on topic.

Thanks to a few abusers I am now moderating comments. I welcome thoughtful disagreement. I will block comments with insulting or abusive language. I'm also blocking totally inane comments. Try to make some sense. I am much more likely to allow critical comments if you have the honesty and courage to use your real name.