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Financial Myths


from Forbes Five Years Of Dodd-Frank: ‘Too Big To Fail’ Still Unresolved by Norbert Michel

The notion that these transactions took place in some shadowy, hidden room of finance, where regulators had no clue what was going on, is absolutely false. Not only did they know, they actually blessed the transactions as safe. Repeatedly.

More broadly, even AIG was regulated. And there was no substantial reduction in financial market regulations in any of the previous 10 decades. Many rules and regulations had been changed over the yearsbut virtually none were eliminated.

Perhaps it’s tradition. The practice of blaming speculators for financial turmoil is as old as the hills. Back in the 1600s, the English Parliament blamed a major crisis on the “pernicious Art of Stock-jobbing.” In 1929, members of Congress blamed the stock market crash (and the Great Depression) on speculators. They subsequently used the event to radically alter federal regulations.

One major piece of legislation was the Glass-Steagall Act of 1933. It prevented – for the first time in the U.S. – commercial banks from engaging in many securities-related activities through companies known as securities affiliates.

Sen. Carter Glass argued that these affiliates “made one of the greatest contributions to the unprecedented disaster which has caused this almost incurable depression.”

Even though the evidence suggests combined commercial and investment banking activities did not cause excessive risk taking, much less the Great Depression, this myth persists to this very day.

Senators John McCain (R-Ariz.) and Elizabeth Warren (D-Mass.) have just introduced a new bill to reinstitute Glass-Steagall restrictions on commercial and investment banking affiliates.

Yet there’s not one shred of credible evidence that these affiliations, legally permitted by the 1999 Gramm–Leach–Bliley Act (GLBA), caused the 2008 financial crisis. It’s just as much a myth now as it was in the 1930s.

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Dumb Regulation isn’t the same as Deregulation


from Jeb Hensarling at The Wall Street Journal, After Five Years, Dodd-Frank Is a Failure:

Dodd-Frank was based on the premise that the financial crisis was the result of deregulation. Yet George Mason University’s Mercatus Center reports that regulatory restrictions on financial services grew every year between 1999-2008. It wasn’t deregulation that caused the crisis, it was dumb regulation.

Before Dodd-Frank, 75% of banks offered free checking. Two years after it passed, only 39% did so—a trend various scholars have attributed to Dodd-Frank’s “Durbin amendment,” which imposed price controls on the fee paid by retailers when consumers use a debit card. Bank fees have also increased due to Dodd-Frank, leading to a rise of the unbanked and underbanked among low- and moderate-income Americans.

Has Dodd-Frank nevertheless made the financial system more secure? Many of the threats to financial stability identified in the latest report of Dodd-Frank’s Financial Stability Oversight Council are primarily the result of the law itself, along with other government policies.

Dodd-Frank’s Volcker rule banning proprietary trading by banks, and other postcrisis regulatory mandates, has drastically reduced liquidity for making markets in fixed-income assets. The corporate bond market is one of the primary channels for capital formation in the economy. Reduced liquidity in this market amplifies volatility. Because of Dodd-Frank, financial markets will have less capacity to deal with shocks and are more likely to seize up in a panic. Many economists believe this could be the source of the next financial crisis.


read the whole article.  This regulation was based on political narratives and expediency, rather than the thoughtful and non partisan analysis such a significant piece of regulation requires.  It seems that our next crisis is the result of the bad solutions legislated for the last crisis.

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Fostering a Liquidity Crisis

From The Wall Street Journal, How the Next Financial Crisis Will Happen by Stephen Schwarzman:

Despite good intentions, however, politicians and regulators constructed an expansive and untested regulatory framework that will have unintended consequences for liquidity in our financial system. Taken together, these regulatory changes may well fuel the next financial crisis as well as slow U.S. economic growth.

The Volcker Rule, for example, bans proprietary trading by banks. The prohibition, when combined with enhanced capital and liquidity requirements, has led banks to avoid some market-making functions in certain key equity and debt markets. This has reduced liquidity in the trading markets, especially for debt. A warning flashed last October in the U.S. Treasury market with huge intraday moves, unrelated to external events. Deutsche Bank has reported that dealer inventories of corporate bonds are down 90% since 2001, despite outstanding corporate bonds almost doubling. A liquidity drought can exacerbate, or even trigger, the next financial crisis. Sellers will offer securities, but there will be no buyers. Prices will drop sharply, causing large losses for investors, pension funds and financial institutions. Additional fire sales will aggravate the decline.

Why should we care? Because new capital, liquidity and trading rules are interrelated, and locked-up markets and rapidly falling securities prices will force banks to reduce assets and hoard liquidity in order to satisfy applicable regulatory tests. With individuals suffering losses and companies not able to raise capital, the economy will contract with layoffs, lower tax revenues and pain for middle- and lower-income Americans.

Small business owners will be particularly vulnerable because the number of community banks declined by 41% between 2007 and 2013. Recent studies by economists at the Richmond Federal Reserveand Harvard University both concluded that the 2010 Dodd-Frank financial law contributed to this decline. Dodd-Frank has disproportionately burdened community banks, despite their having no role in the financial crisis. We must revisit Dodd-Frank’s application to community banks because of their special relationship with borrowers in agriculture, small business and local real estate.


The lack of liquidity in the bond market is already being felt and is increasing volatility. We also see private companies starting to emerge to fill the void from lackluster bank lending.

Systemic changes such as Dodd Frank have some improvements but they tend to fight the last war without realizing their role in the next one.

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Financial Bloat

A black hole for our best and brightest by Frank Tankersley at The Washington Post

It’s not that finance is inherently bad — on the contrary, a well-functioning financial system is critical to a market economy. The problem is, America’s financial system has grown much larger than it should have, based on how well the industry performs.

To understand how and why that is, think of money as water and the financial system as a series of pipes. Ideally, the pipes deliver the water from people who have stockpiled it (investors) to people who want to put it to productive use (entrepreneurs, executives, home buyers, etc.).

Over the past half-century, America’s financial industry built a whole bunch of new pipes. The sector grew six times as fast as the economy overall during the past three decades. Other advanced countries didn’t see anywhere close to that growth in their financial sectors.

Some of America’s growth was driven by Washington. Lawmakers kept encouraging financial innovation, which built a market for smarter investment bankers. They did that by changing the tax code to encourage businesses to hire financial whizzes who could spin ordinary income into certain, preferred types of investment income, and by loosening restrictions on the kinds of financial activities that the titans of Wall Street could engage in.

But starting at about the time that Jackson joined Goldman, when Congress began tweaking investment-tax rates, Wall Street started drawing more educated workers. This made the average finance salary go up — from less than $50,000 a year in 1981 (which is about $100,000 in today’s dollars) to more than $350,000 a year in 2012.

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Why Tax Cuts are Disproportionate

Kevin Williamson writes Blue Voodoo in National Review.


 The cartoon version of conservative economic thinking — that we should subsidize gazillionaires in order to create work opportunities for yacht painters, monocle polishers, and truffle graters — is fundamentally at odds with the facts. The supply-siders may have wrong economic ideas, but they do not have those wrong economic ideas. President Ronald Reagan, for example, loved to boast of the number of poor and modestly-off Americans his policies had removed from the federal tax rolls entirely. George W. Bush promised that he’d take the poorest fifth of taxpaying U.S. households off the federal tax rolls; Heritage estimates that he succeeded in doing so for about 10 million low-income households.

One of the perverse consequences of conservatives’ success in lowering the federal income-tax burdens of those on the left half of the earnings bell curve is that we have finally arrived at the point where our critics are partly correct: Most conservative plans for tax cuts at this point in history do disproportionately favor the wealthy and the high-income, for the mathematically unavoidable reason that they pay a steeply disproportionate share of federal income taxes, making it very difficult to design a tax-cut plan that does not disproportionately benefit them. It’s hard to cut taxes without cutting them for the taxpayers.


The more progressive the tax system is the more that the economy is dependent on the wealthy and thus subject to the same volatility. Tax cuts will favor the rich if the lower income have paid no taxes.