It’s Regulators Versus the Market in This House Debate

Source: stock.xchng

Source: stock.xchng

The Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law by President Barack Obama three years ago. Introduced by former House Financial Services Committee Chair Rep. Barney Frank (D-Mass.) and former Senate Banking Committee Chairman Sen. Chris Dodd (D-Conn.), the Dodd-Frank Act set in motion the largest financial overhaul since the Great Depression.

To a bridge a long story packed with all the highly engaging political drama that only financial regulation could deliver, the implementation of Dodd-Frank has been contentious. Dallas Federal Reserve Bank President Richard Fisher perhaps best captured the situation in June, when he served as a witness during a hearing of the House Committee of Financial Services.

The Dodd-Frank Act is “an earnest attempt to address much needed reform in the financial services industry,” he said, but “its stated promise to end too big to fail rings hollow. Running 849 pages and with more than 9,000 pages of regulations written so far to implement it, Dodd-Frank is long on process and complexity but short on results … Regulators cannot enforce rules that are not easily understood. Nor can they enforce these rules without creating armies of new supervisors.”

Fisher was preaching to the choir, so to speak. The House Committee on Financial Services is chaired by Rep. Jeb Hensarling (R-Texas), a conservative with no shortage of anti-regulatory munitions or the willingness to use them. He was one of many representatives who championed a bill through the House late on Wednesday night called the Swaps Regulatory Improvement Act, a piece of legislation that aims to repeal certain regulations surrounding how major financial institutions like JPMorgan Chase (NYSE:JPM) and Citigroup (NYSE:C) handle their derivatives business.

As it stands, Dodd-Frank requires financial institutions to move their derivatives trading businesses out of house, removing them from the umbrella of government bankruptcy protection. This, in theory, shields taxpayers from any possible losses incurred as a result of risky derivatives trading, an issue that was at the heart of the financial crisis. Firms like AIG (NYSE:AIG) were brought to their knees because of their derivative trading practices, and derivatives were a part of JPMorgan’s London Whale fiasco. Citigroup reportedly lost as much a $2.2 billion thanks to faulty derivative bets.

The cost to financial firms like AIG, JPMorgan, and Citigroup aside (which by themselves can have a negative impact on the broader market), Dodd-Frank sought to limit any cost to taxpayers for bad derivatives bets. The financial crisis demonstrated that if a major financial institution is on the edge of collapse (i.e., AIG), the government will step in and prop it up in order to prevent the potentially catastrophic damage that could be caused by its failure. This is far from ideal, a sort of choose the least bad scenario, and in either case the public is bound to bear some cost.

The other side of the coin, though, is what Fisher spoke about in June and what supporters of the legislation (which passed the House 292-122 with some Democratic support) argued this week: Gratuitous regulation is bad for business.

The legislation seems unlikely to make it through the Senate.

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