Saturday, May 15, 2010

Dodd’s Bailout Bill

Those who have not read U.S. Sen. Chris Dodd’s regulatory bill need not avoid commenting upon it.

The U.S. Congress has demonstrated it is not necessary to read a bill prior to an up or down vote on it. And Dodd’s bill is long, in excess of a thousand pages. Lately, Congress seems to be interested in writing epics where a poem might do, and the average senator’s eyes glaze over after ten pages.

By way of example, U.S. Attorney General Eric Holder, whose staff is capable of engorging itself on thousand page bills and spitting out digestible briefing memos, claims not to have read a ten page Arizona bill he disapproved of publicly – very likely because his staff had already worked up a narrative in conflict with the factual substance of the bill.

Holder also implausibly claimed he was not briefed on the Arizona bill. It would have been impossible for the attorney general to denounce a piece of legislation as possibly racist when he knew the legislation did no more than pattern itself after federal policies that, as attorney general, he is sworn to uphold. In any case, when Holder claimed not to have read the bill before commenting on it, the national news media promptly fell asleep and snored loudly.

Dodd’s massively intrusive bill imposes on banks and financial institutions a regulatory scheme that will be observed only by small lending institutions and financial houses that cannot afford to send to Washington lobbyists charged with persuading powerful regulators to carve out preferments and exemptions. The too big to fail non-banking behemoths, when they do fail, will be bailed out. The Dodd bill institutionalizes bailouts for companies that in the ordinary scheme of things would be thrown into a bankruptcy court and reorganized or dissolved.

In a bankruptcy proceeding, a judge, far removed from partisan politics and campaign cash, considers the claims make upon the company, satisfies the claimants and either dismantles the company or imposes a reorganization upon it. Usually, the assets are parceled out to successful competitors, CEOs are fired and the loss is absorbed by investors.

Fannie Mae and Freddie Mac, two government supported entities (GSEs) that forever will be associated with Dodd & Frank (Barney, U.S. Rep.), should have been declared bankrupt. But the two GSEs were bailed out instead, and when their predictable failure produced a national calamity, they were taken over by their government supporter, the Democratic administration of President Barack Obama. Fannie Mae and Freddie Mac are now owned by the U.S. government; which is to say, their continuing failure will be supported through Main Street tax dollars rather than Wall Street investments.

GSEs are congressional creations. If the GSE fails, its failure is supported by tax bailouts, an arrangement that necessarily creates what economists call “moral hazard.” If a company cannot fail -- and how could any company fail that is supported by the full faith and credit of the U.S. government? -- those who run the company will take risks they might otherwise avoid like the plague.

The possibility of failure, like the possibility of execution in the morning, clears the mind wonderfully, which is why Bill Buckley, addressing students at the Cornell University Graduate School of Business in 1981 said: "I desire, perversely, to sing a song of praise to failure; as well as, of course, to success; and to urge that we reappraise the dialectical voltage generated by these two polarities… Public policy must tolerate, indeed anticipate, economic failure (italics original).”

It should be obvious, both to those who have read Dodd's bill and those who have not, that Fannie Mae and Freddie Mac are government supported failures; and to the extent that the government continues to support mortgage lenders that surrender tax dollars to people who cannot afford to pay their mortgages, the government has institutionalized failure.

There is a good deal of speculation that Dodd’s bill will institutionalize massive failure, transform businesses regulated by it into potential GSEs, and exponentially increase the continuing politicalization of business activity in the United States.

The Dodd bill would create a $50 billion fund that would allow the government to bail out non-bank creditors. The bill invests the FDIC with the authority to offer loan guarantees during a crisis while accepting as collateral dubious assets such as assets such as subprime-mortgage-backed securities. This, according to National Review “is the architecture of a permanent bailout authority, and it needs to be dismantled. If the power to offer such extraordinary assistance is truly necessary in the event of a liquidity crisis, regulators should have little trouble convincing Congress to give it to them. But Congress should not preemptively hand the keys to the fisc to a group of unelected officials who, though well-meaning, have precious little incentive to look out for the taxpayers’ best interest when they believe the sky to be falling”

The Dodd bill, some think, will invite corruption on a massive scale. When investment dollars are allocated by politicians rather than conscientious businessmen through a free market that punishes moral hazard through failure, corruption becomes inevitable. Every regulation is in effect a tax on business that re-directs market forces and reallocates investment dollars. Presently, lobbyists in Washington buy the ears of politicians through campaign contributions. But when the large businesses affected by Dodd’s bill become GSEs, their campaign contributions will buy more than ears: Politicians and political departments in charge of regulations leading to massive reallocations of dollars will be up for sale to the highest bidder.

Presently, lobbyists in Washington buy the ears of politicians through campaign contributions. But when all large businesses become GSEs, their campaign contributions will buy more than ears; they will be buying a fail safe economy doomed to fail massively.

Dodd’s bill should be opposed for these reasons.

4 comments:

Fuzzy Dunlop said...

Don,
Michael Lewis' "The Big Short" is essential reading on the last financial crisis. He doesn't really offer any specific solutions. It's more a chronicle of highminded idiots charading as the smartest group of people in the world. By the end of it you don't know whether to laugh or cry that such a small group of people are capable of blowing it so f*&king badly, dragging the rest of us down with them in the process.

As the book pertains to your post, I really think that the game has become so corrupt and is already so thoroughly rigged that no kind of meaningful reform is possible. Goldman Sachs, for instance, is not by any stretch of the imagination what most people would consider a traditional bank. They add no social value, simply charging the rest of us for, well, nothing, yet as we saw, can put us all in great peril. Worse, they've have become a sort of quasi government entity, a feeder school for the U.S. Treasury Department that is both feared and admired by Republicans and Democrats alike.

Like I said, the game is rigged. The only thing that will make things better is a total reset. Goldman and other institutions already have implicit government backing. I doubt very much that Dodd's bill will do any good... but it cannot possibly make things worse.

In the meantime, perhaps our greater loss will be in terms of intellectual capital, siphoned away by the finance system. Men of intelligence should aspire to become doctors, lawyers (not the kind that works on Wall Street mind you) or CEOs of traditional companies.... but not bankers. Wall Street is simply a place for money to pass through... it should not be a place to make your fortune, and as it continues to lure away our greatest minds, we will all be poorer for it. It has all become a grand tragedy of truly biblical proportion.

Greg said...

Arkansas?

Don Pesci said...

That would be Arizona. Thanks, corrected the goof.

Don Pesci said...

"...but it cannot possibly make things worse."

If it institutionalizes the power of the FDIC to bailout non-banking institutions, things will get much worse, for three reasons: 1) The FDIC does an OK job in bailing out failed banks. If its responsibilities are extended to provide bailouts to non-banks, it will have a deleterious impact everything it does; 2) you can’t secure a loan with fake securities; 3) the bill politicizes lending institutions; try to imagine a politicized judiciary, and you’ll see the problem.

Dodd was chiefly responsible for dismantling Glass-Steagall (http://donpesci.blogspot.com/2009/03/dodd-and-appearance-of-corruption.html) which DID bar financial institutions from engaging in banking functions. This is not an answer to that mistake.

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