Recession Safeguards Are Coming Under Heavy Attack

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Lackluster economic growth in the U.S. has nothing to do with financial services regulatory overreach inherent in new Dodd-Frank rules – as some neo-conservatives would have the American public believe.

Let me say, I'm a staunch fiscal conservative. I am a dyed-in-the-wool free markets entrepreneur. But there's a world of difference between free markets and a free-for-all for financial services oligarchs and officers.

In a July 21, 2014 American Banker article commemorating the four-year anniversary of the signing into law of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Paul H. Kupiec, a resident scholar at the American Enterprise Institute (AEI), makes the misguided case that Dodd-Frank is what's holding back the recovery.

Here's a look at how a recession prevention backstop is coming under siege…

Understanding the (Flawed) American Banker Argument

Just because Mr. Kupiec has been a director of the Center for Financial Research at the Federal Deposit Insurance Corporation and chairman of the Research Task Force of the Basel Committee on Banking Supervision, before hanging his hat at the AEI, doesn't mean his position on behalf of the big-business-centric American Enterprise Institute is objective. It's not.

You can see the July 21 issue for the entire article, but here are excerpts of what Mr. Kupiec wrote in American Banker with my counterpoints attached; see the July 21 issue for the article in its entirety.

The primary goal of Dodd-Frank – preventing another financial crisis – is not at issue. However, well-designed policies must balance costs against benefits. This is where Dodd-Frank fails. It excludes controls that prevent over-regulation and thereby creates incentives that encourage financial stability at the expense of financial intermediation – the monetary transactions that allow goods and services to be efficiently produced and traded, and the means by which consumers' savings are invested.

Shah: The goal of Dodd-Frank preventing another meltdown has not been remotely achieved. Dodd-Frank is barely 60% written and what's been put into place to safeguard the financial system from imploding and ruining the economy again is being challenged by academics and regulators as being unworkable. Dodd-Frank hasn't already failed, that's neo-conservative rhetoric. Mr. Kupiec would rather encourage expensive financial intermediation (for the sake of big banks profiteering) over financial stability. He's got it backwards.

Dodd-Frank grants the Board of Governors of the Federal Reserve, the Federal Deposit Insurance Corp. and the Financial Stability Oversight Council vast new powers to regulate, with no checks on the exercise of these powers. Regulators are directed to exercise their new powers to ensure financial stability and mitigate systemic risk, but financial stability and systemic risk are never defined in the legislation.

Shah: One reason financial stability and systemic risks aren't defined is that the rules and regulations are still being written. Another reason they're not defined is that bankers don't want them defined, they don't want transparency into their inner workings. Mr Kupiec says, "Regulators are directed to exercise their new powers to ensure financial stability and mitigate systemic risk," isn't that the whole point?

Mr. Kupiec seems to worry that the Financial Stability Oversight Council (FSOC), whose members are supposedly the most-in-the-know heads of the country's regulatory agencies, wouldn't be up the task of determining which institutions actually pose a threat to the economy if they were to fail.

The ambiguity of the designation standard provides the FSOC with virtually unlimited discretion. For example, under what conditions should the consequences of failure be evaluated: when the firm fails in isolation, or when the firm fails in a recession during which many other financial institutions are also distressed? Two very different standards may generate very different FSOC conclusions, and yet Dodd-Frank is silent on the issue.

Shah: There is no ambiguity as Mr. Kupiec believes. He asks:

"Under what conditions should the consequences of failure be evaluated: when the firm fails in isolation, or when the firm fails in a recession during which many other financial institutions are also distressed?"

Shah: Who cares if a firm fails in isolation or in a recession along with other distressed institutions? A failure is a failure and any failure of any too-big-too-fail institution, by definition, is a threat in isolation and especially en masse to the system they're all interconnected to. Dodd-Frank isn't silent on the issue, Mr. Kupiec's rhetoric is deafening.

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About the Author

Shah Gilani is the Event Trading Specialist for Money Map Press. He provides specific trading recommendations in Capital Wave Forecast, where he predicts gigantic "waves" of money forming and shows you how to play them for the biggest gains. In Short-Side Fortunes, Shah shows the "little guy" how to make massive size gains – sometimes in a single day – by flipping large asset classes like stocks, bonds, commodities, ETFs and more. He also writes our most talked-about publication, Wall Street Insights & Indictments, where he reveals how Wall Street's high-stakes game is really played.

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