Washington & Wall Street: Is Dodd-Frank Killing the US Economy?
In my last post, “Washington & Wall Street: So Why Can't We Prosecute the Banksters?,” we started to get into some of the historical antecedents of financial regulation. In this post let’s take the analysis a bit further and start with a conversation I had yesterday with Aaron Task of Yahoo’s Daily Ticker, where we talked about how Dodd-Frank and other regulations are hurting credit creation, jobs and the US economy.
In the debate over Dodd-Frank, the Basel III capital rules for banks and other regulatory strictures put in place since 2008, the overriding assumption has been that we need to rein in the risk taking activities of banks to prevent another financial crisis. The many hundreds of thousands of pages of new laws, regulations and comments that have been issued since the start of the subprime bust are all designed, in theory at least, to protect us. But by limiting risk taking we also limit economic growth.
In my 2010 book, Inflated: How Money and Debt Built the American Dream, I spent a good bit of time contrasting two key elements of the American psyche. On the one hand, we have the expansionary, big government, big bank, nationalist perspective of Alexander Hamilton. On the other hand, we have the agrarian, limited government and local perspective of Thomas Jefferson and John Adams. The Federalist Hamilton favored a strong central government and strong, flexible national finance. The Democratic-Republicans, led by Thomas Jefferson and James Madison, denounced most of the Federalist policies, especially the idea of a strong central government that could issue debt or debase the currency to fuel economic growth.
Ultimately the Federalists won the argument, leading to the creation of National Banks in the 1860s, the Federal Reserve System in 1913, various government sponsored enterprises (GSEs) in the 1910s and 1930s, and the vast expansions of the federal debt since the 1980s. Think of each of these periods, many of them closely related to wars, as being layers of leverage created to either fuel growth, finance a military conflict or clean up the subsequent messes.
The period of debt issuance and Fed monetary expansion since the 1980s represents a quantum increase in leverage financed at the national level and coincides with the aging of the Baby Boom. This last phase of credit expansion was facilitated by the Fed and the various GSEs, which use the guarantee of the US government to expand the supply of credit in order to spur economic growth. The largest banks, which are also GSEs, were partners in the latest round of credit inflation and financial bubbles, leading to the bust of 2008. Since then, private credit has been shrinking along with private employment. Millions of Americans have left the workforce.
Seen in this long-term perspective, the Depression era laws and court decisions we refer to generically as “Glass-Steagall” represent the attempt by the political class of 80 years ago to limit private risk taking and credit expansion. The 2010 Dodd-Frank reform law is another such political reaction to private risk taking, although with the difference that this time around nothing was done to limit the expansion of public debt and credit by the Fed and Treasury.
Dodd-Frank attacks credit creation by the private sector, including the quasi-public commercial banks, but places no limits on public credit growth. Since the public sector does not really create any jobs, the net effect is felt in terms of financial inflation visible in asset bubbles in the US (housing, stocks) and around the world, but no significant job growth. Or put another way, the radical monetary policy pursued by the Fed with quantitative easing and low interest rates is being thwarted by the new regulations imposed since 2008.
Dodd-Frank, the Basel III capital rules and other new impediments to risk taking are preventing the creation of new jobs, even as the Fed’s zero rate policies deprive savers of varying stripes of income. The net, net of all of this is the US economy is caught in a deflationary trap, partly due to the need to unwind bad debt and party due to excessive regulation of consumer finance. The central bank is printing money, but only certain parts of the economy are being helped by low rates.
Many consumers, including the elderly, are suffering because of low returns on their savings. And millions of Americans are unable to get mortgages or other types of credit because of new laws and regulations. Put it all together and we find ourselves in a situation not unlike the period between the 1930s and 1960s, when private credit creation was stifled and economic growth was muted at best. Until we adjust our national policies and roll-back excessive regulation, we will have poor job growth and mediocre economic performance overall.