The Awesome Naivete of Dodd's Reform

WASHINGTON-Europe's banking system is falling apart, the stock market is as volatile as NBA basketball, and no one can seem to stop oil spewing into the Gulf of Mexico. Yet the Senate, following the House's lead, has just passed a complex 1,566-page bill to regulate almost every aspect of America's financial sector. Politicians' hubris knows no bounds.

Although Senate and House conferees will not sit down to meld their respective financial regulation bills until June, it already is apparent that they intend to give too much power to government bureaucrats. The White House will actively lobby the conferees and there is no doubt that President Obama will sign the conference bill after it wins final House and Senate approval.

This is the wrong bill at the wrong time. Europe is short of capital as the euro falls in value and its banks restructure debt. Congressional bills would tax American financial institutions and make them less likely to lend, contributing to the global crisis.

The Senate bill, sponsored by Connecticut Senator Chris Dodd (who has decided not to run for reelection), would hurt consumers by raising prices of banking and financial services and prohibiting certain transactions. In addition, it would make future government bailouts of financial firms more likely. Regulators would be empowered to determine which institutions to wind down and which to rescue, leading to further political cronyism.

The bill would raise over $70 billion in taxes over the next decade, with $44 billion from Federal Deposit Insurance Corporation fees, $24 billion in Securities and Exchange Commission fees for registering and trading securities, and $5 billion from Federal Reserve fees on firms "to cover supervisory expenses." Within 10 years of inception, the FDIC would have a pot of $50 billion to bail out financial institutions.

Just reading the list of new bureaucracies contemplated by the Senate bill is enough to make one's head spin. A Financial Stability Oversight Council would watch out for risks to the economy and recommend capital requirements to the Federal Reserve. The Council would be supported by an Office of Financial Research. A Financial Research Fund would finance the Office of Financial Research.

The bill allows a two-thirds vote of the Financial Stability Oversight Council to say that any firm - either financial or nonfinancial - can come under its oversight. It then allows the FDIC and Treasury to treat the firm's shareholders and creditors as they choose, without regard to existing laws.

The list goes on. Senators contemplate an Orderly Liquidation Authority Panel that would decide which firms are troubled, and which are too big to fail. Some troubled firms would be allowed to fail, others wouldn't. Then, the panel would authorize the Treasury Secretary to ask the FDIC to restructure troubled firms that are too big to fail.

Rather than avoid future bailouts, this would pave the way for more. If firms know that they will be restructured and prevented from going under, they would be more likely to take risks and get into trouble. The FDIC would be able to seize and restructure failing financial institutions and create new financial companies to which to transfer existing firms' assets.

That's not all. An Office of National Insurance would decide whether there are gaps in insurance coverage that could lead to a crisis, either in the insurance industry or to the entire financial system, even as AIG's prospective collapse in 2008 was once deemed globally destabilizing.

Senators envisage four new offices for the Securities and Exchange Commission. A new Office of Municipal Securities would protect investors who buy tax-exempt state and municipal bonds, a new regulatory sector for the SEC. In addition, the legislation would create an Investor Advisory Committee, an Office of the Investor Advocate, and an Office of Credit Ratings. Whistleblowers would be given incentives for coming forward, and also protected.

The Federal Reserve would get four new units, with wide-reaching power. The Consumer Financial Protection Bureau would regulate consumer financial products, especially credit and debit card disclosure, and services, including forbidding unfair, deceptive, or abusive acts or practices. Many of these practices are already prohibited under existing law.

An Office of Fair Lending and Equal Opportunity would make sure that more people could get loans, regardless of income and race, even though one of the causes of the economic crisis was driving home ownership too far down in the income scale.

The Office of Financial Literacy would make sure everyone could count. It's assumed that the Consumer Advisory Board would help consumers. Then there's even an Energy and Environmental Market Advisory Committee to provide recommendations and about energy and environmental market issues.

Notably absent from any new regulation are Fannie Mae and Freddie Mac, two government-sponsored mortgage-finance enterprises, which are exempt not only from the Pay Czar's compensation caps but also from the 1,566 pages of regulation.

No matter that Fannie and Freddie have already received $145 billion in taxpayer dollars, and are forecast by CBO to need another $370 billion more over the next 10 years. Rather than neglecting the GSEs, Congress should limit or reduce Fannie and Freddie's portfolios of mortgages and mortgage-backed securities

In all, the pending Senate legislation appears to put a lot of faith in the very regulators who missed the genesis of the 2007-08 financial crisis. And, inevitably, regulation, whether done by Democrats or Republicans, would be politicized. The government would reward its friends, as it did by giving Chrysler and GM assets to the United Auto Workers, and punish its enemies, such as it did with AIG.

Instead of this legislative monstrosity, Congress could create an expedited bankruptcy process to allow large financial firms to be broken up by the courts, with assets sold to the highest bidder.

Only Congress could create a 1,566-page bill with over $70 billion in new taxes over the next decade and a dozen new bureaucracies - and expect it to have a positive effect on the economy. Why don't they also mandate that the oil stop flowing into the Gulf of Mexico?