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Deric O. Cadora is the editor of The DOCument, a daily newsletter offering equity and commodity market cycles analysis, macroeconomic discussion, and general market commentary.…

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A Critique of the Banking Reform Bill of 2009

The recent passage of a financial reform bill by the House of Representatives provides President Obama with a symbolic victory, but how will the elements of this potential new law affect the economic well-being of our country? Let's take a look at the provisions of the bill, along with comments made by its proponents, and ponder what value the legislation would provide to American society.

The bill would create the Consumer Financial Protection Agency to regulate products such as credit cards and mortgages.
The Securities and Exchange Commission has had... for several decades... all the power and information it needs to properly regulate the investment industry, yet the past decade has seen a proliferation of manipulated earnings reports and surprise financial failures. High-profile hedge fund meltdowns over the last year demonstrate what can happen when a government regulatory agency is incompetent or corrupt. Why does anyone expect a different result from more government? An agency such as proposed in this bill would do no more than increase expense to tens of millions of responsible credit card users because the costs of complying with regulatory oversight will be passed along in the form of higher interest rates and fees.

Financial institutions will be required to deposit up to $150 billion into an emergency fund to be accessed when failed companies need to be taken over and broken up.
This feel-good provision is nothing more than an attempt to show the public that government is reacting to their woes, but does anyone seriously believe $150 billion will be enough to tackle the next crisis? Like most reactionary policies, the long-term effect will not be the intended one. The most obvious implication is that the Federal government is positioning itself for more interference of market forces, thereby providing a false sense of security not unlike the repeated bailouts carried out by the Federal Reserve. Also, sequestering such a sum of money will do little more than put a damper on economic activity.

"The bailouts of AIG and Bear Stearns would be not possible... made illegal... under this bill. If a company fails, it'll be put to death." -Barney Frank
We already have a mechanism for putting failed companies to death. It's called the free market economy. In fact, the bailouts exercised during the crisis were already illegal. Why do we need a law to give us what we already had?

The bill would give Congress the authority to order the GAO to audit Federal Reserve Activities.
Congress would have the authority (but not the obligation?) to order an audit of the Federal Reserve. When would such audits be ordered? By what committee? And even if an audit were ordered, it would be performed by an agency that is beholden to a President's political agenda over a central bank whose leaders pull the President's strings. This provision is a weak attempt to reign in the organization responsible for exacerbating the country's economic problems from one crisis to another, yet it is not even clear the authors comprehend that the Fed is the culprit. If the people of Congress really understood the roots of our problems, they would abolish the FOMC, limit money creation to a factor of economic and population growth, and relegate the Federal Reserve to simple oversight functions.

A new council would be created to hunt for trouble at large financial firms and give the Federal Reserve authority to enforce tougher rules.
Mechanisms were already in place for such oversight by both the Federal Reserve and the SEC. Both organizations proved to be incompetent at recognizing trouble. How will this new council be different? Does anyone not see the conflict of interest in giving the Federal Reserve punitive authority over the institutions that own the Federal Reserve?

The Federal Reserve will have to approve all acquisitions of non-financial companies made by a bank when the acquired assets exceed $25 billion.
Our nation would be stronger if we simply reinstate the Glass-Steagal Act and perhaps even strengthen it such that a bank can be a bank and nothing more. Banks should not be direct risk takers. They should simply lend to risk takers in a way that makes a profit while protecting deposited money. Boring. Simple. Safe.

"A major failure of the previous administration was regulatory neglect." -Democrat Majority Leader, Steny Hoyer
This statement is undeniably true. So why doesn't Congress address the issue of preventing regulatory neglect before it heaps more regulation?

The Office of Thrift Supervision would be abolished.
Great! Now let's get on with abolishing a few more useless agencies.

Hedge funds would have to register with the Securities and Exchange Commission.
It is not clear how the SEC will evaluate hedge fund risk nor whether the regulators would really know what to inspect. After all, the agency was handed warnings for several years ahead of Bernie Madoff's demise and failed to act, and some of the financial products are so complicated, that the few who understand them serve those who pay, not those who regulate. Furthermore, if hedge funds of all sizes are required to register, a huge barrier to entry would be raised for small operators in the form of regulatory expenses. Such costs would result in fewer hedge funds, fewer choices for investors, and a larger concentration of power for the big boys... exactly the opposite medicine from what the industry presently needs.

States will be given $1 billion of bailout money to buy abandoned or foreclosed homes and prepare them to become rental properties.
If there were a viable market for this activity, private entrepreneurs would already be doing it. It there is not a viable market, then Congress is simply squandering more public funds. Therefore the provision is either unnecessary or wasteful. In any case, one billion dollars is a diminutive sum and will make no impact on the national economy. Most likely, these dollars are earmarked for a few politically-connected parties.

Regulators will have the power to break up companies that are perceived to threaten the economy, even if the company is healthy at the time.
It seems farcical to expect regulators to suddenly gain the foresight they lacked before the crisis. Even if people within a regulatory agency were to accurately recognize such a problem, would they truly possess the political will to exercise this power? Congress simply needs to admit its mistake and un-repeal the Glass-Steagal Act. Prevention is far more potent than reaction. Furthermore, this provision gives regulators... and thereby Congress or the President... the ability to manipulate financial companies under duress of break-up. It would certainly be disingenuous to believe that such pressure would not occur for political rather than protective ends. Indeed, this provision centralizes power over the economy and moves the United States a big step toward a system it fought for decades: communism.

A new Financial Services Oversight Council would be given the authority to restrict or prohibit proprietary trading at securities firms.
One of the great malfeasances of the Bush administration was the loosening of leverage restrictions for securities firms from 12-to-1 to 30-to-1. Even worse, this exemption was given to only six firms... none other than those with the firing power to threaten our economic well-being. Once again, an admission by Congress of a mistake and a return to prudent regulation is all that is needed.

This legislation is a manifestation of linear thinking and a complete lack of understanding of economics and human action. It reflects our President's continued attempts to be popular rather than constructive, and further centralizes power after a decade in which too much centralization lead to disaster. Expanding government will do nothing to prevent another crisis, but rather guarantees that more of our nation's wealth will be burned in bureacratic fire.


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