Monday, August 30, 2010

The Dodd-Frank Act: Creative Destruction, Destroyed

From Cafe Hayek this morning: "The Europeanization of America’s Economy"

Here’s the truest yet saddest paper title that I’ve seen in a long, long time: “The Dodd-Frank Act: Creative Destruction, Destroyed.” (It’s a new paper by Peter Wallison).
Here's a short snippet from the paper by Peter Wallison:

The dominant theme of the 2,300-page Dodd-Frank Wall Street Reform and Consumer Protection Act is fear of instability and change, which the act suppresses by subjecting the largest financial firms to banklike regulation. The competitiveness, innovativeness, and risk taking that have always characterized U.S. financial firms will, under this new structure, inevitably be subordinated to supervisory judgments about what these firms can safely be allowed to do. But the worst element of this system is that the extraordinary power given to regulators--and particularly the Federal Reserve--is likely to change the nature of the U.S. financial system. Where financial firms once focused on beating their competitors, they will now focus on currying favor with their regulator, which will have the power to control their every move. What may ultimately emerge is a partnership between the largest financial firms and the Federal Reserve--a partnership in which the Fed protects them from failure and excessive competition and they in turn curb their competitive instincts to carry out the government's policies and directions. In addition, with the creation of the Consumer Financial Protection Bureau, the act abandons a fundamental principle of the U.S. Constitution, in which Congress retains the power to control the agencies of the executive branch. These wholesale changes in traditional relationships are hard to explain except as the triumph of a fundamentally different view--a corporatist political model more characteristic of Europe--of the government's role in the U.S. economy.

Key points in this Outlook:

* The Dodd-Frank Act gives the Federal Reserve, under light supervision by a council of regulators, unprecedented control over the largest firms in the U.S. financial system.
* The result may be a public-private partnership, in which the Fed protects the largest firms from excessive competition and failure and they in turn follow the government's directions.
* In the interest of protecting consumers, the act sacrifices the basic protections built into the U.S. Constitution, creating an agency--the Consumer Financial Protection Bureau--that is answerable to no one.
* Ultimately, the act's effort to suppress risk taking will result in a decline in U.S. competitiveness, innovation, and economic growth.

My mother always told me that what's done is done, and there's no sense worrying about decisions that cannot be changed. Still, it is useful to put down some markers about the recently adopted Dodd-Frank Act (DFA), which looks to be the most troubling--maybe even destructive--single piece of financial legislation ever adopted. The reason markers are useful is that they alert observers--especially those in Congress with the power to do something about it--to the problems they should be looking for in the future. And they might even alert regulators--charged with implementing the legislation--to the dangers of taking full advantage of what Congress has offered them. Given these objectives, this Outlook will discuss the most serious policy problems implicit in the DFA.

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