07.13.10

The Ugly Truth About Financial-Regulatory Reform

The financial-reform bill that hits the president’s desk this week is a 2,500-page failure that will only create more problems for federal regulators, argues former SEC Chairman Harvey L. Pitt.

Later this week, the president will sign the Dodd-Frank Wall Street Reform and Consumer Protection Act, and the entire country will witness a “Thalidomide” moment—that special time immediately following a terrible crisis when our elected political leaders, summoning all the self-laudatory instincts they possess, pronounce the latest “crisis” solved by dint of legislative fiat. Dodd-Frank will be our second such financial crisis/Thalidomide event since the new millennium, having been preceded by Sarbanes-Oxley just eight years ago.

We’re about to receive legislation that could better be entitled “The Lawyers’ and Lobbyists’ Full Employment Act.”

As it was with Sarbanes-Oxley, we’ll be told that our last economic crisis was someone else’s fault (but never Congress’) and all we really need is a hefty dose of legislative medicine. And “hefty” doesn’t even begin to describe this dose of legislation. In 2,500 pages of dense prose, we’re about to receive legislation that could better be entitled “The Lawyers’ and Lobbyists’ Full Employment Act.” Which begs the question, what’s the likely impact of Dodd-Frank?

Christopher Chabris and Daniel Simons: Why Financial Reform Will Fail Here’s a scorecard for your consideration:

• Dodd-Frank is a ponderous beast. If Congress were paid by the word or the page, this verbiage might be understandable. But neither of those conditions exists, meaning all we can be certain of is that no one in Congress or the administration has actually read the entire bill.

• Who actually knows what’s in the bill? Passing legislation without understanding its contents is akin to allowing inmates to run the asylum. Only congressional staffers and paid lobbyists know what’s in the bill, and perhaps only specific provisions. In a bill this large, dealing with subjects this complex, all the rest of us know are the sound bites prepared by the shepherding committees.

• The legislation teems with unintended consequences. A case in point is the provision requiring the SEC to establish an investor advocate. Putting to one side the fact that this is the SEC’s mandate, this provision unleashes an SEC adversary—someone who must express unfiltered judgments on the job performance of everyone else at the agency, including the five commissioners, giving this person an unlimited budget and allowing this person to hire outside counsel to sue the SEC or FINRA, if he or she disagrees with their actions!

• The bill sets the SEC up for failure. The SEC is given more rulemaking, more studies and more onerous responsibilities than any other financial regulatory body. Worse, the SEC must now regulate 10,000 hedge funds and several thousand private-equity firms, but was denied what many other financial regulators have—the ability to self-fund its operations. The SEC presumably was denied this authority because the members of its Appropriations Committees don’t want to jeopardize campaign contributions from those the SEC regulates. In particular, the SEC won’t be able to inspect tens of thousands of new firms it will oversee—or pay to get the kind of expertise to compete with the private sector.

• The bill doesn’t do what it set out to accomplish. The most important goal of this bill was to fix the regulatory regime that permitted—and even fostered—the last crisis. Viewed from that prism, the ugly truth is this bill will make our system more vulnerable, not less. What was, and is still needed, is a regulatory regime with better flexibility that is more nimble, and able to spot potentially damaging trends before those trends become full-blown crises. Instead, what we have is a bill that makes government less nimble, and more ponderous. The systemic regulator—the FSOC—can override decisions of individual regulators. The Consumer Financial Protection Agency can bog down any other agency by encumbering agency rules or policies. And worst of all, the bill doesn’t provide the transparency so desperately needed for new products, new services, and new activities. In short, the bill addresses last year’s crisis, but does nothing to prevent the next crisis we’ll surely confront in short order.

In other words: Congress has labored mightily, and brought forth a mouse!

Harvey Pitt, a former chairman of the SEC, is the chief executive officer of Kalorama Partners, LLC.