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Guest Blog: Rep. Ed Royce on Dodd-Frank, One Year Later

Posted By Rep. Ed Royce On July 21, 2011 @ 7:46 pm In Economics | Comments Disabled

Upon passage of the financial reform bill, then-Speaker Nancy Pelosi (D-CA) said, “This is the next critical step forward in an effort to rebuild our economy.” This type of political hubris is reminiscent of what economist Friedrich Hayek referred to as the fatal conceit. Unemployment still stands above 9 percent, business confidence is in the tank and economic growth remains stagnant. As flawed as their claims may sound today, it is important to illustrate exactly where Ms. Pelosi, Mr. Frank and their allies failed so mightily one year ago. Let’s start with the most obvious:

The authors said it would address the causes of the 2008 crisis. From its inception, this reform effort was meant to fit an ideological narrative rather than address shortcomings in our regulatory structure.  Let us not forget the financial crisis had its roots in the decision by Congress to embark on a course of social justice to get everyone that wanted a home into one regardless of whether or not they could afford it.  Over the years, that flawed effort led to the creation of 27 million subprime and other risky loans (representing roughly half of all U.S. mortgages). The most popular conduit for this social justice policy quickly became the two government sponsored enterprises, Fannie Mae and Freddie Mac, which were conveniently left out of the reform effort enacted last year.

The authors said it would eliminate “Too Big to Fail.” With a now popular book and movie bearing this title, Too Big to Fail has become a focal point of the 2008 crisis. Unfortunately, despite the attention it has received, Dodd-Frank compounded rather than eliminated Too Big to Fail. Most Dodd-Frank supporters point to the new Orderly Liquidation Authority (OLA) as a means to mitigating Too Big to Fail. Yet, as Standard & Poor’s recently noted, “future extraordinary government support is still possible” under this authority (i.e. the bailouts will keep coming).  S&P’s report hit on an important point with respect to the government and these behemoth institutions; in times of crisis regulators will always err on the side of more intervention and more bailouts. Dodd-Frank’s OLA simply makes this process easier. As a result, the largest institutions will continue to benefit from the implicit government support, which translates into lower borrowing costs. These goliaths will get bigger while their Too Small to Save competitors will fall by the wayside.

The market confirms this account. Pre-crisis, the top 10 banks in the U.S. held 55% of total assets in the sector; today its 77%.  Much of this has been driven by that funding advantage over smaller competitors (which economists say ranges from 70 basis points to over 100 basis points). Conversely, experts have speculated that the number of small institutions will be halved over the next decade because they do not benefit from the perceived government backstop implicit in Dodd-Frank.

The authors said it would benefit the economy. At $1.25 billion over the next year, the actual budgetary cost to the government seems manageable. The Congressional Budget Office estimates over the next decade, $27 billion will be taken from the economy in new fees and assessments. Unfortunately, because Washington is notoriously bad at gauging the actual economic impact of its policies, only time will reveal the final price tag. Take the last major financial reform effort, Sarbanes-Oxley. At the time, the SEC estimated that internal costs (exclusive of audit fees) of Section 404 would average $91,000 per company. Subsequent studies have shown that the true cost is on the order of $3.5 million per company—more than 35 times the SEC’s estimate. With 387 sets of rules Dodd-Frank is exponentially larger than Sarbanes-Oxley. I’ll let you decide what that means in terms of overall costs.

Now more than ever, thanks to efforts like Dodd-Frank, the drivers of our economy are increasingly focused inward. Rather than looking to finance the next Google or Microsoft, businesses will be mired in complying with 2,300 pages of flawed rules and regulations. From the Consumer Financial Protection Bureau, with its half-billion dollar budget and virtually no accountability or oversight, to the new derivatives regulation, ‘compliance’ with ever-changing dictates will consume these firms. If the end result was a more stable financial system, this may be a cost worth bearing.  Unfortunately, every indication points in the opposite direction; a fundamentally weaker financial system and a less vibrant economy.  This is not an anniversary worth celebrating.

U.S. Representative Ed Royce (R-CA) is a senior member of the House Financial Services Committee and sat on the Dodd Frank Conference Committee one year ago.

The views expressed by guest bloggers on the Foundry do not necessarily reflect the views of The Heritage Foundation.


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