How to Make the Financial System Radically Safer

Clear thinking and discerning rigor when it comes to the twisted state of present economic policy matters brings with it many physical ailments.  A permanent state of disbelief, for instance, manifests in dry eyes and droopy shoulders.  So, too, a curious skepticism produces etched forehead lines and nighttime bruxism.

Nonetheless, these are small prices to pay for the simple delight that comes when a central planner opens their mouth and inserts their foot.  Last Friday, for example, Fed Chair Janet Yellen gave a speech to her friends and cohorts at the annual central banker’s powwow in Jackson Hole, Wyoming.  There she patted herself and the financial regulatory community on the back for what she believes has been a successful execution of financial regulations:

“The events of the [2008] crisis demanded action, needed reforms were implemented, and these reforms have made the system safer.”

How Yellen knows the reforms have made the system safer is unclear.  Like France’s impenetrable Maginot Line, the regulations Yellen lauds are backward looking.  They’re suited to preventing the last crisis while ignoring new and greater threats amassing just beyond the horizon.

No doubt, the greatest of these mounting threats are of the Fed’s own making.  After adding $4 trillion to the Fed’s balance sheet and dropping the federal funds rate to near zero for many years they’re now in the early stages of their great endeavor to ‘normalize’ monetary policy.

But, alas, it’s no longer a normal world.  Years of abnormal monetary policy has fabricated an abnormal world.  Surely something will break before things are bent back into place, assuming they ever get there.

Dead Wrong

The reforms Yellen was referring to include the Dodd-Frank Act.  The Frank part of the regulation, if you recall, is former Congressman, and overall repulsive being, Barney Frank.  Despite being out of office for over four years, Frank’s grubby finger prints continue to besmirch the economy.

The Dodd-Frank Act, which was rolled out in response to the 2008 financial crisis, has turned out to be a classic case of kneejerk regulatory overkill.  President Trump has promised relief to certain aspects of the Dodd-Frank Act’s suffocating regulatory regime, including stress test and capital requirements.  These requirements force banks to keep more capital on their books as opposed to investing it in interest-earning assets.

The rules also dictate how banks allocate their assets between highly liquid securities and illiquid loans – with greater preference for the former.  The roll back of capital and stress test requirements would directly reduce compliance costs for banks and financial institutions.  This would also give banks greater autonomy in how they manage their lending operations.

But Fed Chair Yellen, a dyed in the wool central planner, has a very narrow focus.  In her world, more control via more regulations always provides for a more stable financial system.  Yet she’s dead wrong.

The new financial reforms that were instituted following the 2008 financial crisis have had the adverse effect of constraining economic growth.  U.S. gross domestic product growth has lagged behind asset price and debt growth.  So, too, more businesses are vanishing than are being created.  Barney Frank’s maze of regulations has made it harder for small businesses and entrepreneurs to access the capital needed to grow and create jobs.

How to Make the Financial System Radically Safer

At the same time, the new financial reforms haven’t minimized risk.  Moreover, they’ve set taxpayers – that’s you – up for a future fleecing.  Congressman Robert Pittenger elaborated this fact in a Forbes article last year:

“Even Dodd-Frank’s biggest selling point, that it would end “too big to fail,” has proven false.  Dodd-Frank actually created a new bailout fund for big banks–the Orderly Liquidation Authority–and the Systemically Important Financial Institution designation enshrines “too big to fail” by giving certain major financial institutions priority for future taxpayer-funded bailouts.”

What gives?

Regulations, in short, attempt to control something by edict.  However, just because a law has been enacted doesn’t mean the world automatically bends to its will.  In practice, regulations generally do a poor job at attaining their objective.  Yet, they do a great job at making a mess of everything else.

Dictating how banks allocate their loans, as Dodd-Frank does, result in preferential treatment to favored institutions and corporations.  This, in itself, equates to stratified price controls on borrowers.  And as elucidated by Senator Wallace Bennett over a half century ago, price controls are the equivalent of using adhesive tape to control diarrhea.

The point is planning for future taxpayer-funded bailouts as part of compliance with destructive regulations is asinine.  In this respect, we offer an approach that goes counter to Fed Chair Janet Yellen and the modus operandi of all central planner control freaks.  It’s really simple, and really effective.

The best way to regulate banks, lending institutions, corporate finance and the like, is to turn over regulatory control to the very exacting, and unsympathetic, order of the market.  That is to have little to no regulations and one very specific and uncompromising provision:

There will be absolutely, unconditionally, categorically, no government funded bailouts.

Without question, the financial system will be radically safer.

Sincerely,

MN Gordon
for Economic Prism

Return from How to Make the Financial System Radically Safer to Economic Prism