Tuesday, September 18, 2012
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To Regulate or Deregulate: That Is the Question
This is an economic piece, NOT a political statement. Forgive me for having to start this article with a disclaimer. But Americans are pretty divided these days, and are easily insulted by simply reading a statement that does not concur with their personal views.
You'll find facts in this article, not opinion.
At issue is regulation. Is regulation necessary? And if so, to what degree? What consequences could over-regulation bring?
Rules are essential to the well-being of any group. We can't depend on people to use common sense. That's evidenced by warnings that appear on everyday items. The sad truth is that we would never see a "Not to be taken internally" warning on a tube of Preparation-H unless someone had sued the manufacturer for compensation of damages sustained from making that mistake. The unpleasant aftertaste had to have made food unpalatable for quite some time.
We're also left with a bad taste in our mouth, figuratively, when we read about a CEO who misled investors for his own personal gain or companies who disregard safety for the sake of profit.
So we pass regulations for consumer protection. Almost all with good intention. Yet there is no one-law-fits-all in such a diverse culture as the United States of America. So even those crafted with the noblest of purpose will still inflict harm on others whose interests lay in adjoining activities.
For example, the Community Reinvestment Act of 1977 (CRA) was designed to make home ownership available to lower-income families. Everyone should have the same opportunity to achieve the American dream, right?
To an extent, that's true. But the plain fact is that there are people who just cannot afford to buy a home. So new types of mortgage products were developed to give the impression of being more affordable.
By 1994, CRA rules were drastically revised. Lending mandates on banks were expanded, regulators were given more power to punish banks for non-compliance. Community organizers were given power to file complaints against banks. The applicant's ability to repay the loan played second fiddle to regulatory compliance. Consequences of default were not nearly as severe as those of non-compliance.
Subprime mortgages were the root of the housing collapse that saw more than 4 million Americans lose their home to foreclosure since 2007. The same regulation instituted to assure the American dream of home ownership is responsible for shattering that very dream.
Another example is the Glass-Steagall Act of 1933. Crafted after the Great Depression as a means of avoiding a conflict of interest, it made distinctions between the type of institution that could offer loans, securities or deposits.
In 1999, President Clinton signed the Gramm-Leach-Bliley Act which, among other features, repealed the Glass-Steagall Act. It allowed the same bank that holds your deposit to use those assets to underwrite and trade securities and other trade instruments.
It opened the door for institutions to grow larger than what many consider desirable. It gave them the designation of being "too big to fail."
The financial industry is among the most-heavily regulated in our country. It has to be. The backbone of our nation is the economy. When it suffers, we all do. We're all victims of the consequences as it struggles.
Financial institutions, like GCF Bank, must adhere to nearly 48 different federal regulations along with numerous others imposed on the state level. Compliance can be onerous, as a good deal of resources is devoted to assuring we meet each requirement and proving to regulators that we do so through routine audits.
Affected staff members are in constant audit mode. Exams are scheduled throughout the year, taking about three weeks to compile the data each agency wants to review. Once an audit is complete, results are dissected and policy revamped to meet their recommendations. By that time, another type of audit is rapidly approaching. We've covered this in previous editions of GCFlash, and compiled the best of those articles into a single page you can read here.
Regulations exist in every industry. Lawmakers have been known to enact legislation that benefits their constituents above the common good of our country. Think corn-based ethanol fuel here that reduces food supply, emits more carbon into the atmosphere during production than it saves while running your engine, and destroys the motor of your boat, motorcycle, lawnmower or chainsaw.
Often regulations are passed as knee-jerk reactions to a single incident. We can't focus on likely terrorist suspects or we're guilty of profiling. Instead, every traveler must remove their shoes and package liquids in containers of four ounces or less.
What are the chances someone will use the same tactic to blow up an airplane as one that has already failed? My bet goes with trying something new, something they may be able to slip by security. Yet to give the aura of security, new mothers cannot bottle breast milk to take on a long trip.
Some regulations contradict others. The most famous example was quoted in President Obama's 2011 State of the Union address referring to the salmon industry. Three separate federal agencies are involved in regulating a single species of fish. The Interior Department is in charge of salmon while they're in freshwater and the Commerce Department gets involved when they're in saltwater. Once they're smoked or packaged, the Food and Drug Administration gets involved.
Regulations are not good, and they're not bad. The same goes for deregulation. Anytime a law, or lack of, cripples industry it needs to get fixed. The answer is not always to pass a new law. Sometimes it's the existing one that puts a noose on growth. And every American citizen is threatened by its tightening.
Happy Birthday Dodd-Frank
It's been just over two years since Congress passed The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The Act was intended to avert the next financial crisis, much like Glass-Steagall was enacted to avert a second Great Depression.
But that's where the similarities end. Glass-Steagall enforced a system to avoid conflict of interest in financial institutions. It created a clear cut division of services an institution could offer by charter so that the same bank that held your deposits couldn't use that money to trade securities.
Dodd-Frank completely overhauled the financial arena. It will take several years to fully implement the over 400 separate rulemakings contained in 2,319 pages of this legislation. And what we've seen so far hasn't been very pretty.
The Act created a new regulatory agency called the Consumer Financial Protection Bureau (CFPB). Don't be fooled by a name. This agency has more authority than any other. It's reach extends places you wouldn't expect to fall under their umbrella.
The CFPB has authority over existing consumer financial laws with a broad range of enforcement tools and sanctions. It has the ability to issue cease and desist orders immediately upon notice.
What it doesn't have is a checks and balance system in place as do other government agencies. It has the power to shut down a business at will without permission or input from an outside source.
Merchants saw debit card processing fees reduced to establish a consistent structure. But banks still had to pay the same amount to processors for the privilege of offering debit cards to their customers. The difference in income had to be shifted somewhere.
The consumer was left to balance the shortage. Higher bank fees were instituted to offset the cost. In 2009, 96 percent of large banks offered free checking to their customers. Last year only 35 percent offered that same service.
The CFPB is the first regulatory body to use social media as a platform for consumer complaints. The posts aren't verified for legitimacy so a disgruntled former employee can blast an institution on a page touted as an official website of the United States Government. Consider the effect this can have on a business.
One little-known provision of Dodd-Frank requires manufacturers to prove that the metals they use in electronics aren't mined by Congo rebels. How does this relate to assuring financial consumer protection in America? I'm wondering the same myself.
Another thing you might be wondering is how Fannie Mae and Freddie Mac, the cornerstones of the housing bubble and economic turmoil, are affected by this overhaul. This legislation designed as consumer protection against the very tactics that led to the Great Recession.
They're not touched in the least. Not a single provision addresses the type of problems created by Fannie and Freddie, much less oversight of the agencies themselves.
For as comprehensive a reform as Dodd-Frank proved to be, it left a lot of stones unturned. It was a major upheaval that didn't address the very issues it was intended to resolve. And may just have created a lot more in the process.
On disasters and wars - the economic impact.
After a few weeks delay, we finally get to the discussion of the effect of natural disasters and wars on GDP. As I previously stated, renowned economist John Maynard Keynes believed that natural disasters, and even wars increased output and thus prosperity. Is he correct?
First of all, Keynes was nearly obsessed with the necessity of stimulating demand in a capitalist economy. Hurricanes, earthquakes and wars were convenient "stimulants." Stated differently, such events often created jobs that needed to be accomplished. Restoring destruction from a hurricane or the manufacture of military tanks both create "new demand," and thus previously unemployed workers can quickly be put to this new task. Sounds reasonable.
But what if the new task is not undertaken by the previously unemployed? What if the worker who was previously building automobiles must be reallocated to tank building? In such a case, output does not increase because a tank is produced INSTEAD of an automobile.
Following Hurricane Katrina, many, many workers traveled to the Gulf Coast to assist in recovery. Such workers created much output, but at the expense of what they would have been producing back home. Of course, much overtime was worked during this period, which would equate to a net increase in output.
It has been said that rebuilding is usually to a higher standard, resulting in more productive assets. A colleague of mine recounted how the Florida Keys rebuilt after Hurricane Wilma to a much higher standard. And although the transition was painful, the result was better infrastructure better able to support a higher level economic activity AND the next hurricane. This is astute.
So on this point, both Keynes and my colleague are correct. Generally speaking, natural disasters and wars created unanticipated demand. Such demand, if filled by previously idle workers (unemployed or underemployed) increases GDP.
It is important to note that any such stimulus must be accompanied by monetary accommodation. Stated differently, the central bank (in the U.S., the Federal Reserve) must increase the money supply by a magnitude large enough to "accommodate" the stimulus.
The failure of the central bank to do this during the Great Depression is the primary reason that downturn lasted for over a decade. It wasn't until the U.S. Government cranked on the money printing presses to finance the war that the economy came roaring back.
It wasn't so much the stimulus, but the monetary accommodation to finance the war that ended the Great Depression. It is unfortunate it took a war and the corresponding huge loss of life for the central bank to act.
No citizen should wish for wars, hurricanes or other economic shocks simply to stimulate economic growth. And while it is true such events MAY increase output, GDP and thus long term prosperity, it is simply unacceptable that such events are utilized for this purpose. A better solution is prudent monetary policy with the aim of expanding and contracting the money supply to moderate the business cycle.
Of course, this will only work in a balanced budget situation, a place far from where we are in the U.S. today. Today's monetary accommodation is almost exclusively consumed to finance the mind boggling deficits being accumulated on a daily basis.
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