Financial Regulation and Unintended Consequences

Yesterday, the Dodd-Frank bill was passed in the Senate with a vote of 60-39. The bill is 2,319 pages long and doesn’t fix anything. I would be willing to bet that no Senator or the President has read every word of the bill. Why not have a bill that requires people in congress to read a bill and have a little quiz before they vote on it? If someone in the Senate of Congress can’t understand 70% of a bill why in the world should they be voting on it? The bill will no doubt have unintended consequences. Also there will be no doubt that when we have another “Great Repression” as Niall Ferguson has labeled it that politicians will be blaming: greed, greed, and greed for the cause of the financial crisis. The “greed” argument is weak because if greed was the cause in the most recent crisis why haven’t we had more recessions? I concede that banks and financial institutions made bad business decisions, but that’s part of the profit/loss system. The government continues to bail out not only banks but companies (Lockheed Martin, Chrysler, GM). Bailouts create future moral hazard and will lead risk takers to take even more risk. Why don’t we get Freddie and Fannie Mac out of the mortgage business? I don’t understand why “affordable housing” should be set as a national priority. Now politicians Washington D.C. (a.k.a. Jupiter) are trying to dream up a fix when what they really need is less regulation and not more.
Although no one in the world understands the bill completely let’s work with what we do know. The first part is the “Too Big To Fail”. Regulators would be able to break up trouble companies if the regulators felt the troubled firms posed a threat to the economy. Couldn’t regulators then break up BP if they felt it posed too big of a threat? Another part of the legislation regulates derivatives and requires hedge funds to register with the SEC. This is another idiotic move considering that many companies other than financial institutions use derivatives. In theory, insurance is a derivative because the premium is derived off the risk of the person who is getting the insurance. Stock options are also derivatives because they are based off the price of the underlying stock. Companies like Southwest hedge the price of fuel with futures or derivates contracts. Regulation will increase the cost of derivatives which will be passed on to consumers. The most damaging piece of part of the bill is that the bill establishes the Bureau of Consumer Finance Protection. The agency will establish rules for consumer finance and enforce regulations that cover mortgages, credit cards, and other financial products. Was the Senate aware that we already have the SEC, FTC, and contract law that already addresses this? Clearly, the Senate has not thought about all the unintended consequences that this will bring. As I write this (day after the regulation has passed the market is down -1.5% and the VIX (fear indicator) is up a whopping 10%. It looks like the law of unintended consequences is already at work. I am thinking of a new relationship between regulation and consumer knowledge. I see regulation and consumer knowledge inversely related since people “believe” that regulation will protect them. As regulation increases people will know less and have less incentive to know more. People today have more information than any other generation in history. Therefore there is no excuse to not know. My philosophy is when markets fail use even more markets.