The Sheer Pointlessness of the Dodd Plan

Last week's passage of the Dodd finance reform plan dredged up bad symbolism, none of it good. Indeed, the Wall Street Journal front page headline touted legislation that would be the "Biggest Regulatory Overhaul of Wall Street Since Depression".

Though most of us didn't suffer the federal government's persecution of the productive back in the ‘30s, basic history tells us that reforms back then did nothing to revive an economy on its back thanks to too much government. In that sense, we perhaps shouldn't pin all of the stock market's recent ill health on problems in a country as economically irrelevant as Greece.

Instead, it's fair to suggest that some of the market cratering in recent weeks can be tied to investors slowly, and sometimes violently, pricing aggressive economic intervention the likes of which didn't end the Great Depression, and that won't solve our present problems.

To put it simply, not only is the Dodd Bill scaring investors, it's also completely pointless. To see why, it's useful to address some of the legislation's main bullet points.

First up is the establishment of "a new council of ‘systemic risk' regulators to monitor growing risks in the financial system." A nice idea, but wholly superfluous considering that's what hedge funds and investors already do. Reduced to "speculators" by politicians and commentators, in truth the investors made rich by declining markets in recent years were the very individuals whose successful investing styles exposed where market risk existed.

So to create a government bureaucracy the purpose of which is to root out risk smacks of pure waste. Furthermore, it can't be stressed enough that any individual possessing the true ability to foretell an ugly market future would most certainly not go to work for the government. Instead, these individuals would toil for private hedge funds, and would be paid handsomely assuming their skills enabled them to do what politicians so naively think salary-men in government can.

Within the Fed, the very bureaucracy so blind to the doings within a banking system it's long been empowered to oversee, the plan is to create a "consumer protection division" to enforce "new rules that target abusive practices in businesses such as mortgage lending and credit card issuance." Implicit there is the notion that lenders preyed on hapless individuals unable to pay back what they borrowed, as opposed to dishonest borrowers lying about their financial status in order to prey on gullible lenders.

Whatever the answer, rules made to "protect consumers" make very little sense too considering how skillfully those "evil" speculators once again exposed faulty lending and borrowing practices not too long ago. Indeed, right up to the '08 market collapse, it was the political class in Washington that regularly lauded increased home ownership among individuals of all income levels.  So for the Senate to fund new bureaucratic layers in order to sleuth what profit-interested investors did so masterfully (and for free) is to be disingenuous, foolish, or likely both.

Perhaps most problematic is the plan to allow "the government in extreme cases to seize and liquidate a failing financial company in a way that protects taxpayers from future bailouts." On its face this new rule is dishonest.

For one, the easiest way to protect taxpayers from bailouts would be to fashion a banking bill disallowing just that. Instead, this legislation makes "too big to fail" the rule, will necessarily scare the daylights out of investors, and it will perpetuate the true "moral hazard" in our banking system which is individual depositors themselves.

Explicit in the notion that the federal government can seize a failing financial firm is that taxpayers will pay for liquidations meant to make creditors and depositors whole. As for investors, they'll suffer even greater political risk given the ability of regulators to seize banks for seemingly any reason. Risk is in the eye of the beholder, particular when the supervisor is a federal official burdened by past failures to see what's ahead.

Worse, this kind of government empowerment will ensure an even closer relationship between the financial sector and the federal government, and all that such a scenario entails. Get ready for even more "socially responsible" lending by banks eager to make nice with regulators able to put them out of business at any time.

Considering depositors, contrary to the popular view that bank executives carelessly took big risks that imperiled the health of the financial system, the unspoken truth is that banking "fat cats" saw their net worth eviscerated when their business plans went awry. This wasn't the case for depositors.

Operating with the knowledge that they can place their money in large banks without consideration of the bank's business practices, they represent actual moral hazard for market realities not impacting their deposit decisions. And with our federal minders set to institutionalize "too big to fail" with increased ability to "supervise" the biggest financial entities, depositors will continue to have their oblivious decisions excused by the taxpayer.

Banks will also face at least in the near-term restrictions on their ability to engage in risky trading activities. In short, if suggested trading curbs actually have teeth, banks will see their profit-making ability reduced on the way to irrelevancy. This wouldn't be terribly problematic except for the fact that politicians love to prop up the weak, and the supposed financial overhaul will foster another sector of the economy needing subsidy in order to remain viable.

Ultimately, it can't be stressed enough how pointless this latest financial legislation is. In a rational world, profit-interested businesses would be allowed to both succeed and fail, and their continued existence or extinction would be regulated by similarly profit-interested investors serving as the economy's private sector regulator.

Instead, the U.S. financial sector will soon enough suffer the latest rules which promise not to work, and that will blunt the happy, capitalistic process whereby failures are weeded out of the commercial arena in favor of successes. One might ask when politicians will ever learn, but this legislation speaks to the greater truth that they don't want to.