Monday, May 3, 2010

Dodd's financial bill is a doozy

From the Knoxville News-Sentinel

Sunday, May 2, 2010

The Dodd bill on financial reform is a doozy.

In the bill's summary it says the failures that led to the financial crisis require bold action. Reading that you think the reason why the financial system teetered - the bursting of the asset bubble in housing - would be attacked in the legislation. But lo and behold, in its almost 2,000 pages there is hardly a mention of housing and Fannie Mae or Freddie Mac.

Indeed, there is nothing in the bill remotely connected with the causes of the financial crisis. Instead, Dodd's financial reform bill is another power grab by this bunch of politicians. It creates a single regulator of consumer protection regulations even though there is no evidence that consumer protection has anything to do with the financial crisis. This new agency will be headed by a single political appointee of the president. All consumer lenders, including those only regulated by the states such as small consumer installment lenders, now would be subject to federal oversight.

The new, powerful regulatory czar would be certain to enact rules that would limit credit granting to poorer households and small businesses. There will be a new agency for "financial stability" with another single politically appointed czar. This czar would have the power to shut down a company that might pose a risk to the financial system.

This unprecedented stunning power would leave all large organizations operating at the sole behest of the shutdown czar. Now how this czar would have any idea of who to shut down escapes me. If this czar existed during the tech bubble, companies like Google and Amazon probably would have been shut down as they grew in excess of their valuations. Heaven help us. Within this new agency will be a $50 billion slush fund paid for by all financial institutions that will allow for the orderly failure of big institutions. In essence, the $50 billion would be used to pay out the creditors of the firm being shut down.

This is moral hazard on steroids and ensures bailouts forever.

There is the new single bank regulator that rolls the supervisory functions of the Fed, the FDIC, the Comptroller of the Currency and the Office of Thrift Supervision (S&Ls) into one agency headed again by a single political appointee - do you see a pattern here? There is regulation of hedge funds by the SEC. Well at least it did not create a hedge fund czar. Over-the-counter derivatives are to be regulated by the SEC. Firms that sell instruments that are packaged and sold (securitization) must retain a portion to bear some of the risk usually passed forward into the market.

Such a provision is probably unnecessary since the market will now enforce on the originator the early put back provisions of early defaults and the representations and warranties in each contract. It creates an office of insurance within the Treasury department and an office of credit ratings at the SEC. Now I am certain that Dodd's bill, which is aiming at everything moving in the financial market except the ones most intimately involved in the financial crisis, has nothing to do with the fact the major recipients of lobbying funds from Fannie Mae and Freddie Mac were Sen. Dodd and then Sen. Barack Obama.

But then of course, I am probably naive.

Dr. Harold Black is the James F. Smith Jr. Professor of Finance at the University of Tennessee. He can be reached at
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