The Dodd Bill this Week: Creating Inefficiencies, Codifying Bailouts, Ignoring the Lessons from the Crisis

The Dodd bill for reforming Wall Street rules is on tap this week—the first question will be how long will the GOP hold out in keeping the bill off the floor for debate. We’ve talked about several the problems in the bill on this blog in the past couple weeks. Ultimately though, we are looking at three things here:

  1. This bill is, essentially, an increase in the role of government, giving regulators more direct say over how the market is operating. This misses an essential lesson from the financial crisis: the government can’t regulate perfect safety. We are essentially saying, “government, you really screwed up the past few decades… so here is some more power and authority, hope this time around you pay closer attention.
  2. The bill does NOT deal with the too big to fail problem. There will still be a bailout fund. Counter-parties will feel confident that the government will ultimately come to the rescue. And there is no guarantee taxpayers won’t be pulled into the rescue of a firm (or more than one firm) during a future crisis as the $50 billion insurance pool is gobbled up. Even the FDIC is having to depend on Treasury backing right now. This is not a win or protection for taxpayers. Furthermore, the way the tax to create the bailout pool is going to be assessed, it will be considered a tax deductable business expense, meaning taxpayers will still feel the effects of the tax as revenues are reduced.
  3. The bill will do a lot to reduce market efficiency. The increased authority to government, the increased compliance hoops, and the overall thrust of provisions in the bill (such as limitations on what kinds of products are “safe” for consumers) mean that Wall Street—and by extension the market as a whole—is going to operate with less success and less efficiency.

The Dodd bill is, as The Wall Street Journal has noted, the best version so far of financial reform—though there are provisions in the Frank bill that are much better, such as how to deal with credit rating agencies. But nevertheless, it would be a tragedy to see it pass. Just as the stimulus has subtly made the recovery process slower and build up false hopes in an government funded end to the recession, the Dodd bill would chip away over time at financial markets and make us a less vibrant nation economically.

The twists and turns in the bill are also simply perpetuating problems from the past. By making the system more complicated, and more restrictive, there are incentives built in all over the place for fraud to slip in. Moreover, there are plenty of places for non-illegal activity to build up that is potentially dangerous to market stability, but is favored because of the way the Dodd bill creates perverse incentives. This is what happened before, as firms took advantage of a well-intentioned, poorly-thought out plan for accounting and rantings rules. Gerald O’Driscoll affirms this view in the weekend WSJ: “The idea that multiplying rules and statutes can protect consumers and investors is surely one of the great intellectual failures of the 20th century. Any static rule will be circumvented or manipulated to evade its application. Better than multiplying rules, financial accounting should be governed by the traditional principle that one has an affirmative duty to present the true condition fairly and accurately—not withstanding what any rule might otherwise allow.”

All this means that we will wind up misplacing our security in the hands of an oversight council that will fail and will lead the way into the next crisis and recession. We don’t have to scrap the Dodd bill entirely, but there are a lot of ways it should be changed in order to actually support a sustainable, healthy recovery.