Wall Street Blues

Why the House's new financial reform and consumer protection bill is bad for America

Last week, the House Financial Services Committee approved the final piece of a sweeping overhaul of Wall Street regulations proposed by Rep. Barney Frank (D-Mass.). The full House is schedule to begin debate on the bill today, and a vote could come as early as this weekend as representatives rush to pass the legislation before the Christmas break.

The 1,300-page bill, known as The Wall Street Reform and Consumer Protection Act of 2009, establishes a Consumer Financial Protection Agency, a systemic-risk oversight council, new capital requirements for financial institutions, and a "resolution" authority for non-banks. It also requires financial products like derivatives to be more transparent, overhauls rating agency laws, changes securitization rules, and alters the FDIC bank rescue fund. In short, it seeks to radically change the way Wall Street does business.

The intentions behind the bill are noble, particularly the desires to protect consumers, stabilize the market, keep banks accountable, and ensure fair competition. However, the proposed rules will not actually accomplish any of this. There are five main reasons why the Wall Street Reform Act will be bad for the financial industry and bad for America.

It Formalizes "Too Big To Fail"

Although the major Wall Street firms were never explicitly listed as being "too big to fail" before the crisis, there was always an implicit guarantee from Uncle Sam. That is why Lehman Brothers was shocked when it was forced into bankruptcy. After all, history had shown that regulators didn't have the stomach to let big financial intuitions go under and negatively impact the market. The implicit guarantee altered the risk management psyche of Wall Street executives over the decades, and was a contributing factor to the massive build up of toxic debt.

President Barack Obama, Treasury Secretary Tim Geithner, Fed Chairman Ben Bernanke, and others have all insisted that future Wall Street reforms must end the policy of too big to fail. Yet the current House proposal does just the opposite. The Frank bill vests the Financial Stability Oversight Council with the authority to require "stricter prudential standards" for excessively large or interconnected financial institutions. Furthermore, the Council is required to publicly announce who will be subject to the tighter regulations. Combined with a new $200 billion bailout fund, this amounts to nothing less than the government naming firms too big and too interconnected to fail. In no time, the banks would become like government-sponsored enterprises, "J.P. Morgan Mae" and "Citi Mac."

It Protects Consumers To Death

The House bill includes the creation of a much-publicized Consumer Financial Protection Agency (CFPA). This independent agency would absorb all consumer protection authority from the Federal Reserve and work to ensure the safety of consumers who use financial products like bank accounts, mortgages, and credit cards. Again, it's a noble idea, but it would wind up protecting consumers and businesses to death.

The CFPA will also have the authority to issue burdensome new rules for everything from banks to Wal-Mart to your local newspaper. This will particularly hurt small businesses by decreasing their access to credit and increasing the cost of doing business. And many of those costs would get passed on to the consumer. Furthermore, the CFPA would spawn a massive bureaucracy and create severe conflicts between state and federal law. The agency would even have the power to write and enforce laws beyond the scope of existing legislative authority. There are good ways of reforming consumer protection. The Consumer Financial Protection Agency is not one of them.

It Cripples Prospects for Economic Growth

The House bill creates a new "bailout authority" for non-banks to make sure companies like A.I.G. and Lehman can be easily rescued in the future. This is paid for by a $150 billion tax increase for large financial firms, including those that pose no threat to market stability. This tax will certainly be passed on to consumers, which will hurt both demand for services and decrease the disposable income of individuals and families—both of which are essential to economic growth.

Tax increases are rarely beneficial, but they can be particularly problematic during financial downturns. The tax hike would literally decrease the capital that firms have, making it harder to post a profit, pay workers, and produce affordable goods. Furthermore, the proposed increases in capital and liquidity requirements mean that companies will have less money to develop their businesses with. Combined, the reform package won't work to promote recovery, it will stifle it.

It Damages Employment Opportunities

By increasing the costs of consumer goods and hurting business growth, the Wall Street reform bill simply exacerbates the unemployment problem. By increasing compliance costs for the energy, commercial real estate, manufacturing, automotive, and healthcare industries (to name a few), the bill will leave businesses with less money to hire and retain employees.

The Frank bill also grants federal financial regulators the power to set wages for all employees working at any financial institution under their jurisdiction. From CEOs to janitors, the government will have the authority to approve compensation packages and reject those that don't meet its arbitrary, politically influenced standard. This won't help companies be able—or willing—to hire more workers in the near future.

It Ignores the History of Unintended Consequences

The financial crisis was ultimately the result of decades of well-intended federal policies that had severe negative unintended consequences. Nothing epitomizes this more than the tragic failure that is the Fannie Mae and Freddie Mac mortgage duo. These firms were at the center of the problems caused by mortgage securitization and capital requirement manipulation. Yet the reform bill's sweeping scope does nothing to address these government-sponsored enterprises.

In general, the bill before the House would do more harm than good. There are some useful provisions in here, like breaking the rating agency oligarchy and increasing accountability for the Fed. But ultimately the CFPA and financial stability legislation are only going to hurt small businesses, create moral hazards, reduce competition, and codify the disastrous "too big to fail" doctrine. That's not the type of reform we need.

Anthony Randazzo is director of economic research at Reason Foundation and author of the study "Rebuilding Wall Street: A Review of the White House Proposal for Reforming Financial Services Regulation."