A number of financial observers and members of Congress have stated that a new financial crisis is “inevitable,” this despite the vast body of new laws and regulations put in place since the 2008 financial crisis. Most of these observers blame a lack of effective regulation for making a new crisis unavoidable, but my view is the opposite; that new regulations are actually creating the circumstances for future financial contagion.
Take Alan Blinder, a Princeton University economics professor and a former vice chairman of the Board of Governors of the Federal Reserve System. He is also vice chairman and co-founder of Promontory Interfinancial Network. Blinder worries about the failure to implement Dodd-Frank and the Volcker Rule, among other things, in an interview in Forbes Magazine:
Some people think of the financial markets as a kind of glorified casino with little relevance to the real economy– where the jobs, factories, and shops are. But that’s wrong. Finance is more like the circulatory system of the economic body. And if the blood stops flowing… well, you don’t want to think about it.
Of all of Blinder’s reasons that a future financial bust is likely, the only one with which I agree is the continued existence of the over-the-counter derivatives markets. The implementation of Dodd-Frank is largely contrary to making markets safer, especially provisions like the Volcker Rule. The Volcker Rule actually reduces financial market liquidity. Principal trading by banks had nothing to do with the causes of the 2008 subprime crisis. Just look at the bond market chaos this past June if you want to see the true impact of the Volcker Rule.
Inside liberal media and policy circles, you almost never hear anyone calling for less regulation. To that end, I spoke to Mark Calabria, director of financial regulation studies at the Cato Institute. Back in 2010, he noted that nothing in the Dodd-Frank legislation ended to huge intervention by the US government in the mortgage market nor would it help avoid the next crisis. He wrote:
Perhaps it should come as no surprise that Sen. Christopher Dodd and Rep. Barney Frank, the bill’s primary authors, would fail to end the numerous government distortions of our financial and mortgage markets that led to the crisis. Both have been either architects or supporters of those distortions. One might as well ask the fox to build the henhouse.”
I caught up with Mark last week in Washington. Below are some excerpts from our conversation:
W&WS: We are now three years into the Dodd-Frank process, what is your assessment?
Calabria: “In terms of the regulatory implementation, we are about as far along as one can really expect. Have the regulators missed most of the implementation dates? Yes, but the statutory dates were never realistic to begin with, at least not if you expect the process to comply with the Administrative Procedures Act. And Dodd-Frank is so much vaguer than your typical piece of legislation. Much more is asked of regulators than in a normal rule-making. So I haven’t found the pace or substance of implementation surprising. For the most part, the regulators have been thoughtful and balanced. I am not one to blame regulators for the flaws of the underlying statute.”
W&WS: “Clearly Congress is to blame. But our society thinks that we can avoid bad events via regulation. Are we as a society to blame or should we focus on our elected leaders and regulators?
Calabria: “My biggest complaint would be aimed at Congress, not the regulators. Dodd-Frank was simply never a serious attempt to address the causes of the crisis. Most of the larger issues, such as monetary policy and our national obsession with homeownership, are largely ignored or even made worse. The narrative behind Dodd-Frank, that predatory lending combined with a lack of regulatory tools was behind the crisis is simply false. You start from flawed assumptions and you end up with a flawed bill. Too-big-to-fail is worse a problem than before the crisis. The stance of monetary policy today makes the Fed’s actions, which contributed to the housing boom, look responsible by comparison. My conclusion is that we are almost certain to have another crisis. Sooner rather than later and it will be worse because of Dodd-Frank, not better.”
Bottom line is that nothing in the Dodd-Frank legislation will prevent the next financial crisis. Indeed, Dodd-Frank may be a catalyst for future market breakdowns. Liberals in Congress and the Big Media will blame future contagion on an imperfect regulatory environment, but you can only have fraud in a free society. Dodd-Frank has already done enormous damage to the US real estate market, the full scope of which will become apparent when home prices start to fall next year. Hold that thought.
No amount of additional regulation – short of turning America into an authoritarian police state – will prevent the next financial crisis. And even in heavily regulated markets, the threat of crisis remains. Just look at the European Union, where private financial markets have almost been regulated out of existence and you can see that the possibility of financial crisis continues to threaten those nations. The difference is that instead of housing bubbles fueled by ordinary citizens, in the EU you have idiotic politicians playing financial games with state-owned banks.