What's Missing in the Financial Rules Bill?

What's missing from the Dodd financial regulation bill is any recognition that there is a competitive market out there that can be distorted or destroyed. The bill authorizes the Fed to regulate all "systemically important" nonbank financial institutions, with the power to control the capital, liquidity and permissible activities of the country's largest securities firms, insurance companies, bank holding companies, hedge funds, finance companies and others.

All these firms compete with one another--for customers, investors and credit. The Fed, never having regulated a hedge fund or an insurance company, is now supposed to set the capital levels, liquidity requirements and permissible activities for each type of business and for each individual institution.

The Fed, never having regulated a hedge fund or an insurance company, is now supposed to set the capital levels, liquidity requirements and permissible activities for each type of business and for each individual institution.

If it increases the capital requirements for, say, hedge funds, it will affect their ability to compete with securities firms or bank holding companies. If an insurance company wants to enter the business of insuring municipal securities, it will be fought by bank holding companies, which already do this business. In other words, competitive issues will be fought out at the Fed or in Congress instead of the marketplace.

Finally, and perhaps most important, the bill would regulate the largest financial institutions because, in theory, their failure could trigger a systemic breakdown. This means they are, by definition, too big to fail. All these institutions will thus have significant advantages over their smaller competitors, especially in obtaining credit.

Because they will be seen as less risky, they will have access to more credit at lower cost. They will also have advantages in selling their products. Imagine an insurance company being able to tell its potential customers that, because it is regulated by the Fed and too big to fail, the policies it offers are safer than those of its smaller competitors.

This bill could only have been designed by people who know or care little about how competitive markets function.

Peter J. Wallison is the Arthur F. Burns Fellow in Financial Policy Studies at AEI.

Photo Credit: Flickr user spakattacks/Creative Commons

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