The Mystery of Regulation Via the Federal Reserve

Call it another case of "regulation without representation." Well, it might not be just another case; instead, it could rank as one of the most blatant cases of "regulation without representation" in recent history.

Our elected officials in the nation's capital are notorious for writing legislation that regulates all kinds of activities, and then leaving the actual details of regulating to the bureaucrats. For good measure, there is no follow up, such as requiring that Congress actually vote for or against these rules and mandates. The federal regulatory process, quite simply, is a glaring abdication of lawmakers' responsibilities.

The Dodd-Frank financial regulation law stands out as a glaring example of nonsensical law, which puts enormous power in the hands of government bureaucrats and hurts the economy.

When President Obama signed the measure into law in July 2010, a New York Times report noted, "A number of the details have been left for regulators to work out, inevitably setting off complicated tangles down the road that could last for years." That was the epitome of understatements. As for the epitome of overstatements, the Times piece went on: "But ‘because of this law, the American people will never again be asked to foot the bill for Wall Street's mistakes,' Mr. Obama said before signing the legislation. ‘There will be no more taxpayer-funded bailouts. Period.'"

In reality, Dodd-Frank in no way bars taxpayer-funded bailouts. Indeed, there are only two broad things that we know for sure about Dodd-Frank.

First, we know that it did nothing to redress the problems that generated the housing/credit mess, unprecedented taxpayer bailouts, and one of the deepest recessions since the Great Depression. The causes of this historical meltdown were loose monetary policy, and an assortment of federal laws, entities, subsidies, incentives, rules and regulations that detached home ownership from sound economics. In turn, the private sector acted in accordance with the incentives set up by government, which amplified some of the worst impulses among many borrowers and some lenders. So, all of the key mistakes made by government remain in place. Loose money, imposed in the hopes of ginning up the housing market, is running full throttle; the role of federal entities like Fannie Mae and Freddie Mac, after receiving enormous taxpayers bailouts, actually has been expanded; and nothing has been done to fix assorted laws and regulations that push non-economic mortgages.

Second, given this reality, we know that the massive Dodd-Frank regulatory endeavor will generate enormous costs that will further distort markets; create a false sense of security among the electorate; and further empower unelected government bureaucrats.

Consider Dodd-Frank's much-vaunted Volker Rule, named for former Federal Reserve Chairman Paul Volker, which prohibits banks from undertaking proprietary trading. The rule maker is the Federal Reserve. But Fed Chairman Ben Bernanke told Congress in late February that the Volker Rule would not be ready by its July 2012 deadline, and he was not sure when the rule would be ready. The problem? The Fed is having trouble figuring out what kind of trading by banks would and would not be allowed. That's not surprising. After all, what kind of trading is done on behalf of customers and what is done on behalf of shareholders? For good measure, if one understands markets and the reality that shareholders only benefit in the end when the firm serves consumers well, how can various types of trading really be disentangled?

So, the Volker Rule was silly from the start. It does nothing to redress the actual causes of the 2008 credit/economic mess, and only limits banks abilities to enhance value for both bank shareholders and customers.

As for the enhanced power of bureaucrats via regulation, on February 21, The Wall Street Journal published a powerful front-page story on how the Dodd-Frank regulatory undertakings by the Federal Reserve are going on behind closed doors. While the Fed has emphasized greater transparency in its monetary policy decision-making process, it's rule-making process ranks as the most secretive in the federal government, according to this report.

Consider the following from the story:

"While many Americans may not realize it, the Fed has taken on a much larger regulatory role than at any time in history. Since the Dodd-Frank financial overhaul became law in July 2010, the Fed has held 47 separate votes on financial regulations, and scores more are coming. In the process it is reshaping the U.S. financial industry by directing banks on how much capital they must hold, what kind of trading they can engage in and what kind of fees they can charge retailers on debit-card transactions. The Fed is making these sweeping changes-the most dramatic since the Great Depression-almost completely without public meetings. Rather than discussing rules and voting in public, as is done at other agencies with which the Fed often collaborates, Fed Chairman Ben Bernanke and the Fed's four other governors have held just two public meetings since July 2010. On 45 of 47 of the draft or final regulatory measures during that period, they have emailed their votes to the central bank's secretary."

That's not just troubling. It's scary.

Obviously, the Fed carries heavy responsibility for its own actions, as it is breaking with tradition and with what goes on at other federal regulatory entities. At the same time, though, as the Journal noted, the Fed is not breaking any laws. Congress must take responsibility for not specifically dictating that the Fed needs to hold an open process.

Of course, perhaps those in Congress who passed Dodd-Frank are not too keen on having an open process. After all, an open process just might reveal how clueless and misleading lawmakers were when they passed the law, and how bankrupt and costly the law will turn out to be.

All of this matters to the entrepreneurial sector of our economy, as increased costs, limited returns, and government dictates regarding risk for banks inevitably translate into restraints on the availability of credit and ability to grow.

A February 23 Wall Street Journal story further drives home this disturbing reality. Since stepped up regulations occur when regional banks top $10 billion in assets, the incentives to restrain growth are substantial. The Journal noted, "The new Consumer Financial Protection Bureau oversees the banks above $10 billion in assets, and bank regulators require them to strengthen risk-management measures. Under a Federal Reserve proposal, they also would have to undergo an annual stress test to prove they can withstand economic hardship."

What's the reaction? As reported, "As such, some banks have made the unusual decision of growing more slowly and even turning away money to stay under the regulatory benchmark. Some banks have lowered the interest rates they pay for customer deposits in an effort to attract less cash. And the timing of growth initiatives also is now a factor, as some banks think it makes little sense to trip the $10 billion trigger unless they are to grow much bigger."

The astoundingly misguided Dodd-Frank then has incentivized an entire portion of the banking industry to avoid growing, unless that growth is large and quick enough so as to more easily absorb the added regulatory costs. That's a recipe for reduced savings, restricted credit, less business growth, and therefore, reduced economic and employment growth.

Politicians excel at blaming the private sector for the problems they usually cause, and then causing more problems with additional misguided actions. This most often is the case with regulation, as elected officials make grandiose claims, pass legislation, and leave bureaucrats to sort out the details and private sector businesses and consumers to absorb the costs. Dodd-Frank is a glaring, costly example. What the economy needs is to repeal this grossly misguided law, and instead, implement reforms that actually address the problems underlying the 2008 mess.


Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council. His new book is "Chuck" vs. the Business World: Business Tips on TV.