Insights & Advice


The Dodd-Frank Bill will have unintended consequences

Two years in the making, the Dodd-Frank Wall Street Reform and Consumer Protection Act is 2,319 pages long. It will cost upwards of $30 billion to implement and under the legislation, a minimum of 12 new government reports, 44 studies and more than 243 new rulemakings will be required. Depending upon your political philosophy, this financial reform package is either the best thing since the Declaration of Independence or a giant step toward socialism in the United States.

Time Magazine predicts the bill’s passage is just the beginning since it creates a slew of programs, councils and bureaus within an already cumbersome and heavily regulated structure that oversees the financial system. As in every passage of new and radical legislation, the rules will be fine tuned over time as unpredicted consequences occur in the real life drama of financial activity.

For example, this week, Ford Motor credit’s lending subsidiary wanted to lend more credit to their customer base in order to facilitate more energy-efficient auto purchases. That sounds like a worthwhile exercise. After all, these sales will help grow the economy while contributing to energy efficiency and could mean more jobs down the road here at home. What’s not to like?

So Ford, the parent company, agreed to raise the money in a new debt offering backed by their assets, the car business. Normally, the credit agencies would analyze the financial stability of the automaker’s assets and then give the debt raising their blessing in the form of a credit rating. Buyers of this debt depend upon this rating as a condition of purchase. The higher the rating given by the credit agency, the less risk investors would perceive in the deal and the less interest they would demand from Ford in compensation.

Unfortunately, this system broke down during the period leading up to the financial crisis. Credit agencies were assigning toxic, mortgage-backed securities much less risk than they actually harbored. As these asset-backed securities blew up, it precipitated a financial crisis in the housing sector that swiftly engulfed the entire financial sector and almost sank us all.

The new financial reform bill now makes credit agencies accountable for their ratings with real dollar and cents liability if they rate wrong. As a result, none of the big agencies would allow Ford to put their ratings in its bond offerings’ prospectus. Without a rating, Ford was forced to kill the deal on Thursday.

In my opinion, this is only the first of many unintended consequences that will be generated by this bill. Don’t blame the law makers. They were simply trying to right a wrong from the recent past as they saw it, but unfortunately nothing in finance is simple.

We can expect more of the same as the Dodd-Frank bill meets the complex world of derivatives, CDOs, LPOs and GDOs. So many elements of finance are interrelated that there is normally a domino effect if even one rule changes. Countless other areas, some predictable, some not, will be impacted. Most experts predict hundreds of such rule changes are in store for us, so the months ahead should be filled with red faces, an abundance of televised finger-pointing and opportunities for both parties to say “I told you so” during an election year.

One thing that everyone agrees on is that government has further encroached upon our society. Whether you believe that intrusion is warranted or misguided depends on who you are and what you have at stake. I’m no fan of Big Government, but before I grouse about it, I have to recognize a truism– if a dog is running amuck and snapping at everyone indiscriminately, muzzle it. It was this kind of animalistic behavior, exhibited by Wall Street, which made this regulation necessary. Blame them, not the government for this the largest change to bank oversight since the Great Depression.

Posted in Macroeconomics, The Retired Advisor