The Dodd-Frank Wall Street Reform and Consumer Protection Act: The Triumph of Crony Capitalism, Part 4
Regulators will never keep up with the next asset class boom and bust because they'll always be looking backward.
Editor's Note: This is Part 4 of a multi-part series. Read Part 1 here, Part 2 here, and Part 3 here.
Part 4, Conclusion
Why Regulators Will Always Fail
Why should new regulations work when the old ones failed?:
"We failed completely to understand the complexity of what the impact of the national decline in housing prices would be in the financial system," said Ms. [Janet] Yellen, currently president of the Federal Reserve Bank of San Francisco [and recently nominated as Vice-Chair of the Fed for financial risk]. "We saw a number of different things, and we failed to connect the dots."
The problem with this kind of regulation is that new laws are always looking backward in an attempt to prevent the last bust from happening.
While the origins and outcomes of boom-bust cycles behave similarly, as Rogoff and Reinhart point out in their research, the asset classes and mechanics of the boom are different. As the Fed pumps money into the economy, money follows different paths and inflates and distorts different asset classes each time. In the dot-com boom-bust cycle, money flowed into high-tech companies and the stock market. Before that cycle, money flowed into real estate, mainly multi-family housing. The current cycle pushed money into housing, and more importantly, new forms of debt based on housing that hadn't previously existed.
It's obviously more complicated than this, but the point of this paper is that regulators will never keep up with the next asset class boom and bust because they'll be looking backward. Will they know the "next one" when they see it? I doubt it.
What They Forgot
I discussed in Part 1 of this article that there's almost nothing in the Act that actually prevents the Fed from creating new boom-bust cycles or that inhibits the federal government's policies favoring, and thus distorting, the housing market. Here are things that they should have tackled but didn't.
Fannie and Freddie
The Act failed to deal with Fannie and Freddie. Recall my question at the beginning of this article about why lenders would make unsafe loans. There's no question that the primary movers in the housing boom and bust were Fannie Mae and Freddie Mac, government-sponsored housing financing entities (GSEs). Fannie guaranteed one-half (53%, or about $5.5 trillion) of the US housing market's $10.7 trillion of mortgages; about 10% ($500 billion) of those were subprime ("toxic") mortgages. Countrywide, the largest subprime lender, eventually taken over by Band of America (BAC), sold 90% of its loans to Fannie, and Countrywide's loans comprised 25% of Fannie's purchases.
Fannie and Freddie were nationalized in September 2008 and the federal government assumed their liabilities without limits. As of the first quarter of 2010, Fannie had lost double its profits made for the previous 35 years. They have already cost taxpayers about $85 billion. Estimates of bailout costs range as high as $1 trillion, assuming home values decline another 20% and foreclosure rates continue to climb.
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