Could the Republicans survive Dodd-Frank?

by alexvanbuskirk

Could the Republicans survive Dodd-Frank?

By Peter J. Wallison @ AEI (September 24, 2012)

That’s because this law may be the primary reason the economy continues to struggle.

After the financial crisis and the resulting recession, the U.S. economy actually did begin a recovery. By the fourth quarter of 2009, the GDP was growing at an annual rate of almost 4%. At that point, economists were predicting the V-shaped recovery that usually occurs after a sharp recession. Although 4% was not a Reagan-like growth number (the economy grew an average of 8% for the first three quarters of recovery in 1983), at least it suggested an economy on the move.

But as the Dodd-Frank Act took shape in the first two quarters of 2010, the economy began to slow. By the time the law was enacted in the third quarter of 2010, the average rate of growth of the three prior quarters had slowed to 2.5 percent. But the worst was yet to come. After Dodd-Frank, the average annual growth rate of GDP for the seven following quarters has been only two percent, with the most recent quarter growing even more slowly at only a 1.7 percent annual rate.

Other components of the economy also began to sink. Although the housing market had just passed its historic 3.3% trend line for growth in the second quarter of 2010, the Case Shiller Home Price index shows that it fell sharply beginning in 2010’s third quarter and has not yet recovered the level it had reached before Dodd-Frank. The same is true for manufacturing. Production there had grown to 8% by mid-2010 according to Fed data, but after Dodd-Frank it fell continuously through the rest of 2010 and into the middle of 2011. It too has never recovered its pre-Dodd-Frank level.

The policy uncertainties of Dodd-Frank, however, are of a different order, and why they pose such a danger for the future. It is impossible for anyone in business to know what is meant by the “stringent” regulations — including exposure limits — that the act requires the Fed to impose on large banks and other large financial firms; or what new regulations and costs will be imposed by the Consumer Financial Protection Bureau on small banks and others — from retailers to check-cashers — that have financial relations with consumers. No one can tell whether firms that hedge their financial and supply risks through derivatives will be able to do so in the newly regulated derivatives markets. No one can be sure there will be a liquid and robust market for fixed income securities — or the ability to issue commercial paper and other short-term securities — after the Volcker rule restricts trading by banks. No one can tell whether any but the most creditworthy borrowers will be able to get a mortgage when lenders will suffer significant penalties if borrowers can’t pay, and when private securitizers (but not the government agencies with which they have to compete) will be required to retain 5% of the mortgage pools they sell.

Finally, significant parts of Dodd-Frank are being challenged on constitutional grounds, and just about every major regulation will be challenged in court on grounds that the agency did not have authority under Dodd-Frank to impose it, that the regulation is arbitrary, capricious or unreasonable, or that it cannot pass a reasonable cost-benefit test.

In other words, the uncertainties associated with Dodd-Frank will go on for years. So the question must be asked: if Dodd-Frank is not repealed, will even the Republicans be able to revive the economy?