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Investor's Business Daily


The Four Lessons Of Dodd-Frank We Need To Learn

March 27, 2012

By Nicole Gelinas

The Germans and the British are trying to tell us Americans something important about Dodd-Frank, the financial-regulation doorstopper that President Obama signed into law two summers ago. We should listen.

Last Wednesday, Deutsche Bank, the German financial giant, said that it had found a way to wriggle out of one of Dodd-Frank’s major provisions — the one that forces bank holding companies to hold more capital.

Deutsche will separate its traditional-banking assets from its investment-banking assets in America. That way, it can avoid bringing up to $20 billion in new capital to America to back up the i-banking business. Barclays, the British bank, made a similar move soon after Obama signed Dodd-Frank. Other European and Asian banks may do the same.

This maneuver teaches us four lessons about Dodd-Frank:

1. The law isn’t making us any safer. The point of Dodd-Frank was, in Obama’s words from July 2010, to "bring the shadowy deals that caused this (financial) crisis into the light of day, and to put a stop to taxpayer bailouts once and for all."

Yet this provision of the law directs regulators to pay way too much attention to banks and not enough attention to the rest of the financial system. The reason for this is that commercial banks are responsible for the bread-and-butter lending activities that keep the economy going, and so crises there impact the rest of the economy.

That would be fine, except that it is not true. The big change in the financial system over the past 20 years is that banks weren’t responsible for making long-term loans and keeping them on their books.

Investment banks, hedge funds, pension funds and other nonbank companies indirectly created long-term loans for people and businesses through their purchases of loan-backed securities. This innovation had a lot of good points. But it introduced short-term equity risk — prices go up and down fast — into the long-term debt markets.

Protecting banks, then, misses the point. It doesn’t matter if a commercial bank is perfectly safe if the investment firms that provide long-term debt to the economy via their short-term trading all go under — or threaten to — at the same time, drying up the long-term debt markets.

The best way to prevent a repeat of 2008, then, is not to separate the world into banks and nonbanks, but to impose some simple rules on the world as it exists.

Regulators should require financial firms — banks or not — to hold a consistent amount of capital behind their investments. It’s not regulators’ job to decide which financial firms should be safe and which ones dangerous, nor is it their job to decide which investments are safe and which ones are dangerous.

A regulator’s job is only to make sure that the economy has an adequate cushion of capital to absorb inevitable financial-industry failures. That’s the lesson of the past five years — but the president has not heeded it.

The Deutsche Bank move is an emblem of this failure: regulators will now "regulate" the empty shell that Deutsche vacated, while the activity affecting the economy goes elsewhere.

2. The law is inconsistent and unfathomable. "OK", the regulators might say. "We lost the ability to keep an eye on Deutsche and Barclays by monitoring their ’bank’ activities. But we win, anyway, because Dodd-Frank still allows us to decree that Deutsche is ’systemically important,’ something we may do, soon. Thanks, Obama, for anticipating the banks’ sneaky ways."

Indeed, Dodd-Frank gave regulators discretion to designate some nonbank firms as so important to the economy that they need extra regulation, including capital requirements that could meet or exceeds those of the banks.

But if some nonbanks are just as important as banks — and if it’s so hard to figure out which ones fall into that category that regulators still haven’t figured it out, two years on — then why treat banks differently at all?

3. The law may send business overseas. Deutsche Bank and Barclays got out of this particular Dodd-Frank provision without having to move anything or anybody out of the country. But Dodd-Frank’s "Volcker Rule" likely will still restrict their trading activities — that is, if they stay here.

As Barclays wrote last month to various Washington regulators, "we believe that the proposed rule represents an inappropriate one-size-fits-all approach to the market-making and hedging exemptions that does not properly take into account the way market intermediaries operate, especially in less liquid markets."

If the Volcker rule unreasonably restricts activities, investment firms — including nominally Americans firms — can move those activities elsewhere. We’d lose jobs and income, but without gaining safety. After all, firms trading overseas still represent demand for American securities, and thus can pose a systemic risk to our financial system.

4. Two years on, nobody knows what’s going on. Dodd-Frank should be old news by now. But new maneuvers show that banks and other financial companies are still just figuring out — maybe — how to respond to it.

Companies can adapt just fine to laws good and bad, but they need to know what each law is. Dodd-Frank just told regulators to write tens of thousands of new rules — and they’re working on it.

Original Source:



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