My administration is the only thing between you and the pitchforks.


-President Barack Obama, March 27, 2009



This summer, I visited New York City as part of an orchestra trip to perform in Carnegie Hall. I entered The Big Apple, with a violin case strapped across my shoulder and an umbrella. I left the city with something barely tangential to Beethoven’s Fifth: a keen and growing interest in our American financial and political system. As I stood on the steps of 11 Wall Street, home of the New York Stock Exchange, I couldn’t help but imagine the chaos generated by the fallout of the American financial system in September of 2008 and the battle between politicians and corporate executives that ensued. These days, it is almost impossible to not hear anything about the financial system in the news. A story about the stock market rallying upward is a sign that many Americans will have their jobs for a few months longer. A story about plunging stocks seems like the end of the world. A report about Wall Street compensation is no longer news. Politicians pointing the finger at investment bankers are as common as investment bankers pointing right back at politicians. I hear optimistic stories about how America will never crumble and how the economic recession is just another stumbling block on the path to long-term prosperity. Then, I hear the pessimists: The current economic conditions are expected to worsen by the end of the year....central bankers expect many more job losses to hit...

There is one thing we can all agree on: Never before has there been such scrutiny and public backlash against the US financial system.


Since the great economic fallout of 2008, in what has been dubbed the “worst economic crisis since the Great Depression,” US regulators, politicians, and the public have lashed out against and in more extreme cases publicly vilified Wall Street for its reckless behavior and extravagant compensation practices. In The New Yorker article entitled “What Good is Wall Street?”, John Cassidy argues that much of what Wall Street does is socially useless. Playing on a more vitriolic theme, Matt Taibbi of The Rolling Stones Magazine writes that Wall Street’s most powerful investment bank Goldman Sachs is “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.” This past summer, Capital Hill fired the first major blow in the battle against Wall Street as President Obama and US politicians passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, a 2,300 page legislative behemoth that imposes strict regulatory overhauls on anything remotely related to banks including hedge funds, private equity firms, financial derivatives and credit cards. The architects of Dodd-Frank had clear goals in mind: protect consumers from abusive and complex financial products and schemes, curb dangerous risk taking by institutions and end the perception of “too big to fail” - the notion that firms are too big and wield too much political and economic power that their collapse would put the entire US economy at risk.


While the comprehensive Dodd-Frank Act is a good start to reforming our financial system, it does not get to the heart of what started the financial crisis and jump-starts a level of government overreach and intervention that does more harm than good.


In one of the more controversial portions of the bill, the Dodd-Frank Act essentially creates a new independent watchdog agency to “ensure American consumers get the clear, accurate information they need to shop for mortgages credit cards, and other financial products, and protect them from hidden fees, abusive terms, and deceptive practices.” The creation of the Consumer Financial Protection Bureau, an independent consumer watchdog, aims to deliver a much-needed dose of consumer focus and protection previously absent in our regulatory regime.


While a consumer watchdog agency may sound appealing on paper, the bill would allow the Consumer Financial Protection Bureau to write and enforce rules affecting a wide range of companies including all financial institutions, from large Wall Street investment banks to small community banks, the latter of which had no conceivable connection to the financial crisis. Furthermore, by requiring small community banks and student loan lenders, the vast majority of whom were the victims rather than the culprits of the financial crisis, to adhere to a strict set of regulatory rules imposed by the Consumer Financial Protection Bureau, Dodd-Frank restricts credit and easy lending at a time when credit is badly needed in our communities. In addition, the agency is funded and housed within the Federal Reserve, an institution that has been repeatedly criticized for not watching out for consumers in the first place and has long resisted consumer protection. This paradoxical framework lends itself to problems down the road.


Perhaps the most widely-voiced critique of Dodd-Frank is its colossal failure to properly diagnose what caused the financial crisis in the first place. According to Stanford economist John Taylor, “the biggest misdiagnosis is the presumption that the government did not have enough power to avoid the crisis.” In fact, the government did have enough power but either chose not to act sooner or chose to act in a way that, in retrospect, stirred more uncertainty into the financial markets. With appropriate foresight, the Federal Reserve had the power to rein in excessively low interest rates that contributed and accelerated the housing bubble in 2008, but chose to restrict cheap credit when it was clearly too late. The US government could have more closely regulated financial derivatives, a class of financial paper that, when used properly, can reduce market risks but when used inappropriately, served more like a gambling casino for quick profits by large investment banks. Government enterprises Freddie Mac and Fannie Mae purchased risky mortgages with the support of Congress only to find themselves with bad pile of investments months later. And the US Treasury, along with the Federal Reserve, designed a systematic set of bailouts to the most troubled US banks costing taxpayers billions only to find that, nearly three years later, some banks have yet to service their debt.


The government had all the powers already in play. But rather than reengineering existing regulations to make them more effective, Dodd-Frank vastly increases the power of government institutions in ways that are unrelated to the recent crisis. Even worse, the financial regulation bill created pages after pages of new agencies and new powers for the government institutions that many believe allowed the housing bubble to metastasize into the full-blown financial crisis. The increased power of existing regulatory bodies in tandem with the creation of at least 13 new federal agencies will tack on billions of dollars onto the already downward spiraling US budget deficit. Why should we believe that new agencies and expanded powers will work when the old ones failed and sufficient regulatory power existed to begin with?


Most importantly, Dodd-Frank does not solve the problem of companies becoming “too big to fail.” Yale economist Robert Shiller expresses a similar sentiment, writing in The Huffington Post that Dodd-Frank “is not going to eliminate the problem of systemic risk, because it’s a very difficult problem. It involves the nature of the banking system, which is inherently vulnerable.” In other words, the US financial system contains risk that, by nature, cannot be eliminated. Rather the goal is to reduce, or contain, that risk. Immediately after the fall of venerable investment banking giant Lehman Brothers, the US government and the Federal Reserve initiated a series of bailouts that put the taxpayers on the hook for bad investment decisions made by corporate executives. Seeing this, regulators thought of a way to fix this problem by allowing government regulator bodies to takeover a failing company. While Dodd-Frank empowers the government and government agencies such as the Federal Depository Insurance Company (FDIC) to seize and liquidate any firm that may pose a systemic, or global, risk to our economy, this alone does not mean that firms won’t be too big to begin with now or in the future. Can we reasonably expect that breaking up big banks and corporations that the US economy has depended so heavily on for job creation and growth for decades won’t necessarily come at cost to economic prosperity?


Perhaps the most blatant omission is any mention to reform Fannie Mae and Freddie Mac, the government institutions that provided mortgages to homeowners throughout the US and purchased the risky mortgages from Wall Street to begin with. According to statistics from the Congressional Budget Office, the costs of the Fannie and Freddie bailouts may reach $1 trillion when it’s all said and done. Fannie and Freddie hold roughly 70% of all US mortgages and are bleeding billions by the month on bad mortgage purchases, suggesting that our housing crisis is a long way from being over. While Fannie and Freddie did not directly contribute to the housing crisis, the sheer size of the institutions and their integral role in financing home purchases in the US are too large and important to ignore. The failure to place any mention of Fannie and Freddie further fuels the growing Wall Street frustration that the government is glossing over its own mistakes while repeatedly blaming the banking community. This certainly does not help ease tensions between Wall Street and Washington to say the least.


On a broader note, what implications will Dodd-Frank have on our nation’s economy at an unprecedented time of sky-high unemployment and stagnant growth? Capitalism is the most vibrant, flexible, and efficient economic system and the foundation for unparalleled US economic growth in the last century. Innovation, risk-taking and an unceasing sense of entrepreneurship propelled the US from an agrarian society in the 1800s into the world economic leader she is today. Absent from US economic policy was any prolonged period of government intervention or statues dictating what banks and companies must do with their assets and capital. With the signing of the Dodd-Frank Act, our economic landscape would drastically change. While the intentions of Dodd-Frank are to reign in excessive lending practices and preach responsibility to corporate America, the ill-conceived consequences entail a restriction in the supply of credit that will necessarily jeopardize private sector growth. Through layers of provisions that ultimately make credit more costly and less available for small businesses, Dodd-Frank obliterates private sector job growth at a time when credit should be available for creditworthy consumers, small businesses and entrepreneurs.

Despite the mixed reports the Dodd-Frank bill has received so far, the fact that politicians are thinking about these issues and proactively looking for ways to fortify our financial system points to a brighter future direction. The continuing debate and the plethora of arguments against and for the Dodd-Frank Act are no doubt good news that people are more carefully examining the possible repercussions of unfettered government power and negative economic impacts. The Dodd-Frank Act has its virtues and Democrats can proudly claim it to be the most comprehensive financial reform act in US history. However, without the right diagnosis, we cannot expect to find the right cure.






















Works Cited

Carpenter, Daniel. “Why Consumers Can’t Trust the Fed.” The New York Times. March 16, 2010

Cassidy, John. “What Good Is Wall Street?” The New Yorker. November 29, 2010.

Javers, Eamon. “Inside Obama’s Bank CEOs Meeting.” Politico. April 3, 2009.


Johnson, Simon and James Kwak. 13 Bankers: The Wall Street Takeover And The Next
Financial Meltdown. New York: Pantheon Books, 2010. Print.

Leisman. “Fannie-Freddie Bailout Could Cost Taxpayers $1 Trillion.” CNBC News. June
29,
2010.

Shiller, Robert. “Dodd-Frank Does Not Solve Too Big to Fail.” The Huffington Post. October 10,
2010

Strassel, Kimberly A. “About that Financial Reform ‘Victory.’” The Wall Street Journal. July
16, 2010.

Taibbi, Matt. “The Great American Bubble Machine.” Rolling Stone. April 5, 2010.

Taylor, John B. “The Dodd-Frank Financial Fiasco.” The Wall Street Journal. July 1, 2010.

The United States Senate. “Brief Summary of the Dodd-Frank Wall Street Reform and
Consumer Protection Act”

Wallison, Peter. “The Dodd-Frank Act: Creative Destruction, Destroyed.” The Wall Street
Journal. August 31, 2010.