Unintended Consequences of Dodd-Frank Act

In reaction to the 2008 financial meltdown, the government came up with the Dodd-Frank Wall Street Reform and Consumer Protection Act.  Signed into law in 2010 by President Obama, its name implies consumer protection.  Reality does not match the implication.

The 2008 financial meltdown occurred because of bad behavior on the part of consumers, lenders and financial institutions.  This led to the possibility that major financial institutions would fail worldwide leading to governmental bailouts of mega banks and other corporations, justified by the claims that the institutions were too big to fail.  It is impossible to determine the accuracy of this claim.  However, the possibility of systemic economic failure in itself seemed to justify the interventions.

Successful capitalism demands that the imprudent borrowers, lenders, and shareholders should have suffered catastrophic losses as a result of their behavior that so badly damaged society.  Instead the bailouts saved those who most deserved punishment.  Worse this has led to increased likelihood of such imprudent behavior being repeated.  Instead of allowing this appropriate economic response, the government gave us the Dodd-Frank Act, which is not only ill-conceived, but too complex to fully comprehend, let alone its consequences.

If indeed the banks were too big to fail the government should have responded by breaking them up so that they could not cause systemic damage to the economy in the future.  Not only have the banks not been broken up, but Dodd- Frank resulted in banking consolidation with the large banks becoming even larger and more dangerous to greater society.  This increases the potential need for even larger bailouts in the future.

Some of the unintended consequences of Dodd Frank remain unknown.  Others, such as banking consolidation, are apparent.  Another consequence was announced earlier this month by insurance giant MetLife.  They will divest a large part of their US life-insurance business, which generates approximately a fifth of their total revenues.  Because this MetLife falls within the purview of Dodd-Frank, it was required to increase its capital base.  Instead of taking this step MetLife will make the announced divestiture with its spokesman saying: “aAn independent new company would be able to compete more effectively and generate stronger returns for shareholders…[and] this risk of increased capital requirements contributed to our decision to pursue the separation of the business.”

The fact that MetLife is making a divestiture of a major business unit is not in itself problematic.  However, making this decisions based on governmental regulations is an inefficient way to regulate economic activity.  This divestiture will allow both MetLife and the newly created life insurance company to skirt Dodd-Frank and will likely result in weaker companies providing life insurance to consumers increasing consumer risk.

In typical governmental action, Dodd-Frank attempts to corral horses that already left the barn.  Like Sarbanes-Oxley before it, Dodd-Frank will increase the cost of doing business, create more regulatory jobs, and be a boon for the accounting and legal industries.  Ultimately, consumers will suffer and the politicians and bureaucrats that gave us this mess with be retired on huge government pensions.