Economic Effects of the Dodd-Frank Act

The Dodd-Frank Act is the solution to a problem that does not exist, and is therefore totally unnecessary. The causes of the 2007-2008 financial crisis were not private sector greed and mendacity. As we noted earlier, the real-estate bubble that started the crisis was actually caused by government insistence that banks originate subprime loans. The Department of Housing and Urban Development even required that such mortgages constitute at least 56% of all new mortgages. That is, 56% of all new mortgages were to be to people below the median income for their community. (See reference [E4, chapter 1]). The federal government actually mandated the real estate bubble!

Not to be caught with their hands in the cookie jar, politicians (mostly from the Democratic Party and opposed by Republicans) publicly blamed banks originating subprime loans as the prime cause of the “Great Recession”, and crafted the 2010 Dodd-Frank Act. The main purpose of the Dodd-Frank Act was to bring banks, financiers, stock markets, and commodity markets under government regulation and control. This monstrosity of a law is far too large to be adequately summarized in a post of a mere thousand words, so I will content myself with commenting on some of the most destructive aspects of the law. If your interest is piqued, there are a large number of books and internet resources on the subject. I would particularly recommend references [E8] and [E9].

Dodd-Frank is the most comprehensive, intrusive, and costly regulation of the financial industry in the entire history of the United States. Most of the articles I have read in researching this subject have added the phrase “since the Great Depression” or “since the New Deal”, but I would be willing to wager that Dodd-Frank could outdo anything that the old NRA could do in intrusiveness and costliness. As with many U.S. statutes these days, the Congress delegated actual rule-making (i.e. the making of administrative law)  to a large number of executive branch agencies and departments (Treasury, Housing and Urban Development, Labor, and State). Peter Wallison, a true authority on financial markets, Fannie Mae and Freddie Mac, accounting policy and Dodd-Frank, has written in the Wall Street Journal

There is always a trade-off between regulation and economic growth, but Dodd-Frank—by far the most intrusive and costly financial regulation since the New Deal—placed few if any limitations on regulatory power. Written broadly and leaving regulators to fill in the details, the act has often left regulators in doubt about what Congress meant. Even after regulations have been finalized, interpreting them can be a trial. For example, the regulations implementing the inconsistent Volcker Rule, which prohibited banks and their affiliates from trading securities for their own account, took more than three years to write, but key provisions are still unclear.

Can there be any surprise if regulations spawned by this monstrosity are often inconsistent and costly? Can there be any doubt that banks and other financial investing institutions would be hesitant in taking any risks when they know that a Dodd-Frank regulator could smack them down and perhaps send them to prison? Without risk-taking an economy can not innovate, grow, and become more productive.

Speaking of risk-taking in investments, we should take note of the “robust” regulation of traders in commodities (also see here and here and here), stocks and bonds. This is despite the fact that these markets had absolutely no role in inflating the real estate bubble whose bursting caused the Great Recession. Oh, well, as Democratic politicians always say, they should “never let a good crisis go to waste”!

One of the areas of greatest damage that Dodd-Frank has done is in small community banks (also look here). Among the key areas of concern for community banks are increased reserves deposited with the Federal Reserve (more than doubled from $100,000 to $250,000 per depositor), additional regulatory hoops banks must jump through to qualify as an “accredited investor”, and the implementation of a modified Volcker rule that restricts their ability to invest in their communities. The bottom line for it all is that Dodd-Frank, in increasing compliance costs and regulatory burdens is making it difficult for community banks to make loans to all but their most credit-worthy customers. Historically, small community bankers used detailed knowledge of local businesses to fund those which were most promising for growth. Especially coming out of a recession, these small, young businesses were the greatest sources of new jobs. Since Dodd-Frank has made it much more difficult for community banks to do this job, we should not be surprised that the recovery from the 2007-2008 recession has been both slow and with very low growth rates.

Much, much more could be said about the very bad effects that Dodd-Frank has had on the economy. Those who are interested are referred to references [E8] and [E9]. What every one of us should hold upper-most in our minds is that all this economic damage is totally gratuitous. None of the economic activities regulated by the law had anything to do with the cause of the Great Recession. THAT was the insistence and the mandate of the Federal Government for the origination of subprime mortgages by banks.

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