Congress broke this weekend not quite done on "financial
reform." A defeat of this bill would help avoid a double dip
recession. The bill is dishonest because it does not deal with
) or Freddie (
), the main engines of our collapse.
The bill's deafening silence on these two means that it is
posturing, not helping. In the short term, which is what you would
think Congress cares about, the bill is deflationary because it
takes precious capital from the banking industry while cutting
alternatives available to consumers. It is not a coincidence that
the stock market is breathing heavily and making new lows as the
prospects for this "overhaul" have brightened.
Some of the main features of this bill and its drawbacks appear to
Moving financial derivatives on to exchanges
. This will have the net effect of driving some of this business
from New York to Chicago, and some overseas to places like Hong
Kong, with a net loss to the United States.
Banks will be limited in proprietary trading to 3% of
This implementation still has too much risk for the taste of
Secretary Volcker, who wanted a complete ban. The thought that it
is a good idea to limit risk by limiting proprietary trading
while still leaving Fannie and Freddie to continue unfettered
after they lost us over a trillion dollars is ludicrous.
Requiring most derivatives parties to post sizable
While government has a role in managing risk, once private
parties have done their deal, the usual unintended consequences
of imposing NEW contract terms from the outside are to cause the
NEXT party to hesitate. One consequence of this will be that a
lot of assets will be frozen or liquidated or just idled to
provide "safety" at a time when our biggest danger is that the
velocity of money has slowed to a crawl, making deflation more
New wind down procedures will be put in place that
essentially codify the ad hoc seizure of banks like Washington
Mutual that left shareholders with nothing when under normal
procedures they might have gotten something.
This will apply to arguably solvent banks too. Once burned, twice
shy investors will not come running to invest in bank equity
knowing that what they have can more easily be seized by the Feds
or affected by other arbitrary rules.
Raising capital requirements for banks in accordance with
Basel 3 and disallowing most Trust Preferreds as
The less free capital they have, the less they can lend to
consumers and small business job creators.
Speaking of the consumer, the new "watchdog" will limit
the products they can grab onto when they're in real
Suppose the only lender who will lend to you is a payday lender,
but you need the money to keep your car insurance in force. If
the Feds make that choice disappear, an accident can put you into
bankruptcy. Why limit choices?
The Fed will referee the fight between merchants and
banks on credit card fees, with an eye towards getting merchants
more of the pie than before.
Given all the pressure on their profits from this and other
provisions, banks may make it up by charging for bank accounts.
So now the consumer will earn no interest on their checking
accounts but get charged for keeping their cash with banks. Huh?
It looks like savers will be penalized and spendthrifts rewarded.
Many savers, angered by the fees, may simply pull their deposits
out of banks and put their money under the mattress, sort of like
the Great Depression.
National mortgage standards will apply so that banks will
have to figure out if a new mortgage loan will be
What? Isn't that what banks used to do before Fannie and Freddie
led them down the garden path by buying almost every mortgage in
sight? Congress should just let banks fail that continue to lend
to people who don't repay. The banks will figure it out. One
national standard is more likely to create systemic failure than
the diversity of hundreds of local standards.
Credit rating agencies would have two more years of
monopoly power, finishing with an SEC study of their
Let the market make the calls and get the credit agencies out of
public shelter for their oligopoly.
Sadly, this is not even a comprehensive list. In theory, the
bill is not all bad, just mostly bad, in a fragile economy that
needs animal spirits more than anything else. In the short term, it
will be highly deflationary. In the long term, it may become more
inflationary as it increases the politicization of the Fed. No
wonder we're starting to feel bipolar. Congress needs to break its
cycle of addiction to legislation, and take the summer off without
pausing to fire another shot into the belly of the economy. The
nation could use a breather.
The Congressional Effect Fund owns short term Treasury Bills, and
while congress is on vacation S&P 500 Futures
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