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The Many Problems With Financial Reform

Former Federal Reserve Chairman Alan Greenspan warned in the Financial Times of the hugely market distorting effects of the Dodd-Frank financial bill this week. A day later, the chairman of the Congressional Budget Office testified before the House financial oversight committee about the fiscal impact of the reform act that was hammered out by lawmakers this summer.

Dodd-Frank, for starters, creates many new federal bureaucracies, including the Consumer Financial Protection Bureau, the Financial Stability Oversight Council, the Office of Financial Research and the Office of National Insurance.

CBO estimated that those new organizations would widen deficits by $6.3 billion this decade. Greenspan added that the country is almost certain to “end up with a number of regulatory inconsistencies whose consequences cannot be readily anticipated.”

Additional funding would be made available for existing programs that provide mortgage relief, neighborhood revitalization and grants to encourage individuals to move from nonbank financial services to traditional banks. Those provisions were estimated by to have a cost of $1.5 billion.

The unintended consequences of the law could be all the more dramatic. Before Dodd-Frank, the Credit Card Accountability, Responsibility and Disclosure Act of 2009 imposed federal restrictions on the terms and conditions of credit card services, requiring, among other things, that:

  • Credit card providers allow for a minimum of twenty-one days for bills to be paid;
  • Credit card providers lower the interest rates of clients who have paid their bills on time for six months in a row;
  • Gift cards and gift certificates remain valid for no fewer than five years.

By restricting the ability of financial firms to cover credit risks, the regulations caused higher interest rates and fees. This especially hurt small businessowners and low income families who rely heavily on credit—the very people supposed to be protected by the law.

In anticipation of Dodd-Frank, the Federal Reserve in December proposed to reduce banks’ share of debit card fees associated with retail transactions, “leading many lenders to contend they would no longer be able to afford to issue debit cards,” according to Greenspan.

The former Fed chairman worried particularly about the foreign exchange derivatives market leaving the United States unless the Treasury enact an exemption.

These “tips of the iceberg” suggest a broader concern about the law, noted Greenspan: “that it fails to capture the degree of global interconnectedness of recent decades which has not been substantially altered by the crisis of 2008.”

The act may create the largest regulatory induced market distortion since America’s ill fated imposition of wage and price controls in 1971.

True to his free market roots, Greenspan also attacked an important premise of the financial reform effort—that regulators could forecast and presumably prevent all undesirable repercussions that might happen to a market when its regulatory conditions are importantly altered. “No one has such skills.”

The problem is that regulators, and for that matter everyone else, can never get more than a glimpse at the internal workings of the simplest of modern financial systems. Today’s competitive markets, whether we seek to recognise it or not, are driven by an international version of Adam Smith’s “invisible hand” that is unredeemably opaque. With notably rare exceptions (2008, for example), the global “invisible hand” has created relatively stable exchange rates, interest rates, prices, and wage rates.

A return to the simpler banking practices of half a century ago is probably not the answer to the complexities of modern day finance. Not “if we wish to maintain today’s levels of productivity and standards of living.”

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