Are Dodd-Frank Reforms Slowing Economic Recovery?

Are Dodd-Frank Reforms Slowing Economic Recovery?


With the recovery apparently slowing down, stock markets suffering a recent setback, and an estimated $2 trillion of capital sitting on the sidelines, a number of pundits, wealth managers, and traders have been arguing that uncertainty resulting from the Dodd-Frank Wall Street Reform and Consumer Protection Act is stymieing investment and hiring.

Over 200 rules are expected to be written; rules that will implement the Act’s requirements for capital ratios maintained by banks, liquidation processes for winding down failed banks, and transparency requirements for the derivatives market.

Dodd-Frank was the Democrats response to the melt down in the financial markets and the high number of residential foreclosures.  Dodd-Frank is also intended to provide an orderly wind down of large financial institutions once deemed too big to fail.  In addition to liquidation requirements for financial institutions, there is an oversight council made up of current financial regulatory agencies such as the Federal Deposit Insurance Corporation, the U. S. Department of Treasury, and the U.S. Securities Exchange Commission.

Dodd-Frank also created the controversial Consumer Financial Protection Bureau, with the intent of creating an uber-watch dog to protect consumers from incidences of financial fraud.

In addition to the uncertainty of rules here at home, American banks may be one step closer to international requirements that they increase the amount of capital held on their balance sheets.  Over the past weekend, the Basel Committee on Banking Supervision issued proposed rules that would require banks deemed as too big to fail to maintain additional capital in the form of common stock on their books as a hedge against the type of systemic failure that almost brought the financial system to a halt in late 2008.

During a recent interview with Bloomberg News, Robert Kelly, chief executive officer of Bank of New York Mellon, noted that regulators are not writing the new rules implementing Dodd-Frank fast enough and that this delay may have a negative impact on the economy by slowing down growth. In addition, according to Mr. Kelly, the financial industry will see their costs for regulatory compliance going up.

Mr. Kelly went on to say that consumers of financial services may see a reduction in products and services while the poorest of American consumers may see even less access to credit.

The president of the Federal Reserve Bank of Dallas, Richard Fisher, in a speech delivered in July 2010 stated that businesses and consumers are being confronted by changes in taxes and rules governing behavior and that they are uncertain as to how to proceed on future spending and investment.  “Excessive uncertainty hinders one’s ability to even calculate the odds of potential outcomes, especially when that uncertainty involves irreversible decisions with long term implications”, Mr. Fisher said.  Businesses are distressed by the lack of consistent direction coming from Washington, Mr. Fisher added.

Not every observer or commenter is buying into the “we are too afraid to tip our toes into the water” argument.  The Progressive Policy Institute’s Scott Thompson commented that the rhetoric of the Republican Party calling for a moratorium on new regulations should not be confused with legitimate business planning concerns and their need for long term clarity.

Other commenters have found little evidence that connects the assertions of regulatory uncertainty with diminished business investment or decreases in hiring.  James Lardner, in an article for Remapping, found that business managers and owners are really more concerned about stronger regulation versus uncertain regulation and that the slow down in the economy has a lot more bearing on investment and hiring decisions as opposed to regulatory uncertainty.

The most immediate effect of the unwillingness to invest or hire in the United States is increased unemployment, particularly among African Americans.  Unemployment for blacks hovers around 16% and has been in the double digits for two years.  Bringing back capital to the United States may have a positive impact on black unemployment in the immediate to long run.

The short term impact should raise concern, particularly when it comes to credit.  As corporations hoard cash overseas, the price of capital or interest rates may be staying artificially high.  When the international rules on capital requirements take effect later this year, the cost of capital may increase even more as less cash is available for circulation in the economy.

While additional capital may help cushion the impact of another credit crunch, it may mean reduced access to consumer credit, as citizens try to make ends meet during periods of unemployment, and reduced access to commercial capital, as entrepreneurs try to create their own employment or expand their existing businesses in order to take advantage of new opportunities.

The nexus between regulatory uncertainty and a slow down in the economy becomes increasingly ambiguous when we look at the basic definition of economic slowdown.  An economic slowdown is primarily indicated in slower changes in the growth of gross domestic product or output.  Businesses hire and invest when they see derived demand for their products.  If the economy is growing slowly if all, then there is little or no demand for product and businesses decide whether to slow down investment or leave a market all together.

Rule changes are always a constant threat to a business.  Just read any annual or quarterly report for canned language on regulatory threats.  Have regulatory threats been enough to ever stop a business cold turkey?  Not in the slightest.  While the costs of complying with rules are always a legitimate concern, most businesses take the approach of keeping their eyes on the prize, consumer demand, with the knowledge that they will have to be flexible in terms of hiring or firing employees or increasing and decreasing orders as they are informed of changes in rules.

Continued focus on growing the overall economy may be the best approach for alleviating concerns about regulations.