In the aftermath of the 2007 financial crisis, the federal government moved to tighten the government’s control of the financial industry through several major pieces of legislation which create several new layers of regulations and bureaucratic agencies to “rein in” the financial industry.
Chief amongst these efforts is the Wall Street Reform and Consumer Protection Act, also known as the Dodd-Frank Act, which created many new restrictions on financial instruments and activities. The new regulatory powers include a consumer protection agency, the Consumer Financial Protection Bureau and the creation of a single federal bank regulator.
The act replaces market-based financial monitoring with government bureaucracies, many of which lack oversight and are completely unaccountable for their actions or budgets. Supporters of the new regulations argued the prior regulatory system did not do enough to prevent or mitigate the financial crisis. But the new regulations and bureaucracies under Dodd-Frank will do little to prevent future crises. Dodd-Frank places great faith in regulators’ ability to predict and detect problems that could affect financial markets, but these regulators include many of the people who missed the systemic problems that led to the crisis.
Opponents of Dodd-Frank say the new policies repeat many of the government’s mistakes while failing to address the most pressing problems of the previous regulatory system. Although parts of the new regulatory system under Dodd-Frank remain unimplemented, we are now beginning to see some of the economic effects of the implemented regulations.
Dodd-Frank, along with the myriad other regulation punitively imposed on the financial industry repeat many of the government’s recent mistakes in housing finance, imposes needless new regulatory burdens, and fails to address the most pressing problems. These new regulations have put smaller financial companies at a disadvantage, leading to further industry consolidation. The creation of additional regulatory barriers to lending and higher capital requirements for banks have made new credit less available to investors and entrepreneurs. The new rules also threaten to increase the prices consumers pay for their products while curbing the products and services offered.
Poorly constructed regulations can cause more harm than they prevent. A prime example of a public program gone awry--and one of the key causes of the financial crisis is the Community Reinvestment Act (CRA). CRA was designed to ensure that all homeowners were treated “equally” by avoiding “redlining,” the deliberate shifting of financing away from low-income or high-risk areas. While CRA was designed to serve a positive goal, the economic implications of the new regulation were far more complicated. CRA required mortgage lenders to provide loans to riskier clients, often in stark contrast to what market forces may have dictated. This was done by incentivizing mortgage lenders to make loans for homes in certain zip codes and also by penalizing perceived failures to do enough.
These new loans spawned the subprime mortgage market, a financial sector that is now embroiled in controversy, whose collapse triggered the current downward economic trend. CRA is in many ways socialized financing, forcing banks to lend counter to market trends, thus increasing the risk of failure. We are now caught in a financial downturn that has emerged as a direct result of these risky loans. Any expansion of CRA that limits market flexibility and unnecessarily increases risk is not good policy: A financial collapse benefits no one.
Good financial policy allows the market to grow and thrive while protecting consumers and investors from unscrupulous business practices. Risk will always exist, and the government cannot regulate it away. Efforts to do so only cause further harm.