'Obamacare' for the financial industry

Lawrence Jackson/White House

President Barack Obama delivers remarks and signs the Dodd-Frank Wall Street Reform and Consumer Protection Act at the Ronald Reagan Building in Washington, July 21, 2010.

Article Highlights

  • The best way to understand the #Dodd-Frank Act is to think of it as Obamacare for the financial industry

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  • Raise the red flags. Treasury secretary #Geithner has been given authority over all the financial regulators.

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  • Dodd-Frank puts the financial services industry on a course toward domination by a few large firms chosen by government

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All the Republican presidential candidates have called for repeal of the Dodd-Frank Act. Foreign governments are sending delegations to Washington to complain about the act’s Volcker Rule. Eighteen months after the legislation was signed into law, the president had to make a clearly unconstitutional recess appointment in order to get a director for the act’s Consumer Financial Protection Bureau past near-unanimous GOP opposition in the Senate. In the midst of a housing depression, the entire private housing finance system has ground to a halt while waiting for the regulators to define something Dodd and Frank called the Qualified Residential Mortgage.

Yet none of these consequential events has moved discussion of the Dodd-Frank Act from the business pages to the front pages, or warranted more than a mention on the evening news. As a result, most Americans have no idea how radical this legislation really is.

The best way to understand the Dodd-Frank Act is to think of it as Obamacare for the financial industry. Like its health care counterpart, it leaves the members of the massive financial services industry as privately owned firms, but blankets them with so much regulation that they are no longer really independent operators. If the act is fully implemented, a U.S. industry once so aggressive and innovative that it came to dominate the world’s financial markets will be reduced to a ward of the U.S. government. The current controversies over the Volcker Rule and the Consumer Financial Protection Bureau, for all the attention they have drawn, are really minor matters compared with the overall structure and effect of the act. Indeed, its most significant elements are hardly discussed at all, even on the business pages.

Like its health care counterpart, the Dodd-Frank law leaves the members of the massive financial services industry as privately owned firms, but blankets them with so much regulation that they are no longer really independent operators.

Let’s start with the Financial Stability Oversight Council (FSOC). Ever heard of that? It’s a new agency made up of all the federal financial regulators—the SEC, the CFTC, the Comptroller of the Currency (regulator of national banks), the FDIC (regulator of most state-chartered banks and insurer of all banks), and of course the Federal Reserve (regulator of bank holding companies and soon-to-be regulator of the entire financial system)—to name just a few.

The chairman of this body is the secretary of the Treasury. Right away, this should raise red flags. The secretary, a top officer of every administration, has now been given authority, through the FSOC, over all the financial regulators. To put this in perspective, before Dodd-Frank, Treasury and White House staffs were forbidden to contact the independent regulatory agencies about policy matters, except under special circumstances, for fear of political interference—or the appearance of political interference—in matters of regulatory policy. Under Dodd-Frank, the council is also exempt from the Federal Advisory Committee Act, so its meetings are not open to the press or public.

In other words, longstanding policies that were intended to promote confidence in the independence of regulatory decision-making have now been wiped away by the act, which has in effect placed all the financial regulators under the direction of the Treasury secretary. This might be good or bad, depending on your view of how much power you think a president should wield, but the point is that this profound change in government policy was never seriously debated in Congress, and is largely unknown to the public.

And power there is. The council may designate any financial firm as a “systemically important financial institution” (SIFI) if in the council’s judgment its failure could cause “instability” in the U.S economy. This applies to all financial firms—insurers, securities firms, finance companies, hedge funds, pension funds, perhaps even mutual funds and private equity firms, and of course banks. All banks and bank holding companies with assets of more than $50 billion are designated as SIFIs in the act, but the designation of nonbank financial firms as SIFIs is left to the FSOC. Other than the $50 billion threshold for banks, there are no numerical or empirically discernible standards for this decision. The FSOC has put out draft regulations for comment that cite such things as “interconnectedness” as a factor in the designation, but how they are to be measured is left completely in the council’s discretion.

Designation as a SIFI could have profound effects on the future of the U.S. financial system. In effect, it is a statement by the government that any firm so designated is too big to fail. As we have seen before—with Fannie Mae and Freddie Mac, the largest banks, and the auto companies—if the government thinks the consequences of failure are unacceptable it will step in. The results of this policy are visible in the banking field, where the largest firms are acknowledged to be too big to fail and have been shown to have lower costs of funds than their smaller competitors.

This is logical, since extending credit to a financial institution that is deemed too big to fail is bound to be safer than making the same loan to a competitor that is unlikely to receive government support. The lower cost of funds of Fannie and Freddie—a benefit derived from their government connections—enabled them to drive all competition from the sector of the housing finance market they were allowed to cover. Accordingly, if as expected the FSOC goes forward with its SIFI designations this year, the entire financial services industry will be set on a course toward domination by a few large firms that have been chosen for special government attention.

The stakes associated with this designation are also enormous for the firms involved. A firm designated as a SIFI is then turned over to the Fed for what the act calls “stringent” regulation and supervision. The Fed’s authority is plenary, with the ability to control the firm’s leverage, liquidity, capital and activities. This is truly unprecedented.

All of these large firms are in competition with one another, so the Fed has the power to pick winners and losers among business models. If the Fed declares, for example, that finance companies must hold more capital, it will raise the costs of these firms in their competition with banks, and if the Fed waves its wand and decides that insurers must increase their liquidity, it will change their investment performance in comparison with mutual funds or pension funds. The Fed, in other words, has now been substituted for the market itself in allocating resources to competing industries. 

One of the dangers here is a huge increase in what has come to be called "crony capitalism." Under Dodd-Frank an unwholesome partnership between the government and big finance is actually legislated. This is especially worrisome in light of the Fed's extraordinary cooperation with the Treasury during the last few years. Treasury policy and Fed policy have been virtually indistinguishable since 2008, and the Dodd-Frank Act tightens this alliance by placing the Fed chair under the direction of the Treasury secretary in the FSOC. The Fed's direct control over the day-to-day operations of the SIFIs it will supervise thus gives both the Treasury secretary and the Fed chair an opportunity to exert pressure on the largest financial firms for support of administration policy. 

In the future, it will certainly be ill-advised for the head of a SIFI to express opposition to the Fed's monetary policies, the Treasury's tax policies, or the president's trade policies; a Fed finding that the firm needs more capital could be the unfortunate result. Meanwhile, a SIFI's willingness to endorse the administration's policies in any area might earn it the opportunity to make a favorable acquisition or to count on Fed relief if it fails to meet regulatory standards. 

Nor is the Treasury secretary's power under the Dodd-Frank Act limited to control over SIFIs. Anyfinancial firm is subject to seizure by the secretary if he believes that it is in danger of failure and that its failure will cause financial instability. If the firm objects, it can request a court hearing, but the hearing is secret (it's even a crime to disclose it) and the court has a single day to make a decision. If the court does not act, the secretary can seize the firm and hand it over to the FDIC for liquidation. Needless to say, once that happens, the usefulness of further appeals is vitiated.

Does this sound like America? How can this have happened without most people knowing about it? The answer is found in Rahm Emanuel's iconic remark, "You never want a serious crisis to go to waste." The Dodd-Frank Act is over 800 pages in its enrolled version and was rushed through the Democratic Congress-with almost no Republican votes-in a little over a year from the time the Obama administration announced its plans. It is every bit the ideological sibling of Obamacare, and if it survives it will have as profound an effect on the future of the U.S. financial system as Obamacare will have on health care. 

Unless the Dodd-Frank Act is repealed, the era of big government -if it was ever really over-will certainly be back.

 

 

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About the Author

 

Peter J.
Wallison

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