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Dodd-Frank: A Fence that Should Stay Up

— November 14, 2016

As G.K. Chesterton once said, “Don’t ever take a fence down until you know the reason it was put up.” I hope President-Elect Trump’s transition team has considered Chesterton’s advice as they plan their attack on the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”).

A bit of history. There are a few different ways that wealth is generated in the modern economy. One is by extracting resources from nature, such as mining minerals, or growing food (which can often be thought of as mining the soil, but that’s a topic for another time). Another is by adding value to these resources through labor, such as turning steel into cars or transforming commodity corn into hamburgers. The third, and by far the most dubious, is by moving money around. This third form, the finance industry, doesn’t create useful physical products like the first two; instead, it creates financial products like credit default swaps, that are packaged and sold as investments. Those who use credit default swaps are paying a fee in order to buy a kind of insurance against defaults on debt they own, just like people buy car insurance to protect them in the event of an accident. In theory, this is a good thing because it spreads out risk. However, when holders of default swaps think of them only as a source of income (from the fees they collect) while forgetting that they also are a potential liability (just as your car accident is a cost for the car insurance company), problems can happen.

The modern economy is complex. It’s no longer just about cars and hamburgers: the finance sector controls a growing share of national GDP. The financial crisis of 2007-2008 began with real estate, as everybody thought the housing market would always and only go up, up, and up some more. They weren’t making any more land, right? So banks originated a lot of mortgage loans, both to prime borrowers and to riskier borrowers, since the value of homes always goes up, right, and even if the borrower didn’t pay the loan back, there’s always foreclosure. The problem comes in when the value of real estate happened not to go up, and the risk of these mortgages had already been spread to a larger market via credit default swaps. Foreclosing on one home in an area that’s rising in value is worthwhile for a bank, but when a bunch of foreclosures happen everywhere all at once, that starts a downward spiral of lowering property values that force other homes “underwater” and …well, if you’re old enough to be sidling up to 30, you probably remember what happened. If you’re young enough, this economic reset probably lowered your lifetime earning potential.

Remembering what happened is why Dodd-Frank was signed into law by President Obama in 2010. It’s a complex law for a complex economy, but the purpose was to make a financial crisis like the one in 2007-2008 less likely to ever happen again. Some of the provisions of Dodd-Frank include protecting consumers from shady practices like predatory lending, requiring banks to have a plan for orderly and fast dissolution should they become insolvent, a potential requirement for them to have larger cash reserves on hand to minimize their leverage, and the Volcker Rule, which prohibits banks from engaging in some kinds of financial speculation or risk-taking for profit.

So when one of the incoming Trump administration’s goals is removing the Dodd-Frank fence, one hopes they remember well why that fence was put in place. At best, they are engaging in unfortunate reactionary brick-tossing through some key Obama legislation at the behest of the Trump supporters who sent him to Washington as a way to break things and panic the elites. At worst, they are planning to deregulate banks in ways that will set in motion the conditions necessary for the next financial meltdown. Remember how bad it got in 2007-2008 in Middle America, with families losing their homes and breadwinners losing their jobs? Will a return to those times really Make America Great Again?

Dismantling Dodd-Frank is a giveaway to the financial industry. As the financial industry grows, inequality increases. Graphic courtesy of
Dismantling Dodd-Frank is a giveaway to the financial industry. As the financial industry grows, inequality increases. Graphic courtesy of

Even more cynically, the dismantling of Dodd-Frank is the very antithesis of the kind of hope and change that voters sent Trump to accomplish on their behalf. By potentially driving more families out of their homes and telling them “You’re Fired,” the Trump team is setting the stage for the immiseration of Americans. Desperate people tend to sell off their assets at fire sale prices. Predators with sufficient capital love recessions for this reason, as they can swoop in and pay pennies on the dollar for homes and small businesses that families toiled and saved for years, maybe generations, to build.

Dismantling Dodd-Frank is a giveaway to the financial industry. As the financial industry grows, inequality increases. It plays roulette with Main Street in order to enrich Wall Street. If Trump’s supporters voted for him because they (rightfully) distrusted Hillary Clinton’s Wall Street ties and because they thought he would work to benefit families and small businesses instead of favoring his cronies and engaging in straight-up business as usual, they might live to regret lobbing that Molotov cocktail at Washington. If they want a wall, this is a better place to build one.


Donald Trump’s Transition Team: We Will ‘Dismantle’ Dodd-Frank
Trump Team Promises To ‘Dismantle’ Dodd-Frank Bank Regulations
Trump team vows to dismantle Wall Street reforms
Dodd-Frank Act: CNBC Explains
Frenzied Financialization
Graph: How the Financial Sector Consumed America’s Economic Growth
Turns Out the Housing Crisis Wasn’t All About Subprime
Crash course
G.K. Chesterton
Martinez, Mark A. The Myth of the Free Market: The Role of the State in a Capitalist Economy. Sterling, VA: Kumarian, 2009. Print.

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