The Dodd-Frank Bill: Reassessing “Reform”

On July 21, 2010, President Barack Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law. Touted by the left as a remedy to Wall Street’s excess and opacity, the bill severely increases regulations on the financial industry. But is it effective? In an address to the media, Obama claimed:”The American people will never again be asked to foot the bill for Wall Street’s mistakes. From now on, every American will be empowered with clear and concise information you need to make financial decisions that are best for you.”

It has been almost a year since the act’s passage and American consumers have yet to see substantial benefits from the reform. On the flip side, however, the banking and financial industry have been hit hard by Dodd-Frank, with the numerous regulations increasing costs and cutting into profits. Clearly, there is value to transparency on Wall Street, but the cost of reform begs the question of whether Dodd-Frank is truly a worthwhile endeavor.

Within its 2,300 pages, Dodd Frank has some merit, such as calling for greater accountability in rating agencies. But Alan Greenspan, former Fed Chairman, claims that the entire reform is flawed in theory. Citing Adam Smith’s “invisible hand,” Greenspan asserts that these massive regulations will inevitably create market distortions that could have devastating effects on the economy. Believing regulators are being given too much artificial authority, Greenspan stated that, ”regulators are being entrusted with forecasting, and presumably preventing, all undesirable repercussions that might happen to a market when its regulatory conditions are importantly altered. No one has such skills.”

Greenspan’s theoretical objections to Dodd-Frank have already begun to materialize as the legislation has had unintended consequences. For instance, regulations preventing banks from placing certain charges on consumers—such as capping interchange fees at 7 cents a transaction—have caused banks to search for alternative means to charge clients. These alternate methods have included charging annual fees on debit cards and increasing ATM fees. Thus, just as Greenspan warned, regulations that distort the market can yield unpredictable consequences. In this particular example, consumers may actually be worse off, as banks are now levying more fees on consumers to account for their losses due to Dodd- Frank.

In addition to creating market distortions, Dodd-Frank fails to achieve its main purpose. Created in reaction to the 2008 Financial Crisis, the reform’s primary purpose is to prevent another potential meltdown. Yet Dodd-Frank’s insistence on consumer protection may actually be fueling another credit bubble—the underlying cause of the 2008 disaster. Regulation over the past decade has consistently resulted in the expansion of mortgage credit, which in turn created the housing bubble. While Wall Street was indeed partly at fault for the crisis, due to its proliferation of collateralized debt obligations and faulty credit ratings, government sponsored mortgage lending was the leading driver of the collapse. Supporting the subprime market through Fannie Mae and Freddie Mac, the government enabled the accumulation of high-risk loans that ultimately precipitated the meltdown. But instead of changing the government’s approach to mortgages, Dodd-Frank still maintains “government-imposed lending quotas” on banks, leading America down the same path that led to the financial crisis.

Rather than focusing on complex regulations, a simpler approach would be to address the dangers of easy credit. As demonstrated by Greenspan, the more complex economic regulations become, the more unpredictable the market becomes. While Dodd-Frank clearly attempts to aid the average American consumer, it may be doing more harm than good, while simultaneously ignoring the larger issue of credit.

The House has already voted to repeal Dodd-Frank, and GOP leaders in the Senate have introduced a repeal bill as well. However, this repeal bill has almost no chance of getting past a Democrat controlled Senate.

Regardless of what happens to the status of Dodd-Frank, it is important that policymakers know that regulation is not always the answer. In continuing to stress lending-quotas, Dodd-Frank is perpetuating a dangerous precedent that will ultimately need to be addressed.