Whether you approve or disapprove of the proposal by Senators Brown and Vitter to require big banks to hold more capital, this proposal offers confirmation that the Dodd-Frank Act has failed.
Dodd-Frank has failed because it is not seen outside of Washington DC and the financial regulatory community as actually making the US financial system safer.
Regular readers know that your humble blogger has been saying since Day 1 that there are only two elements of Dodd-Frank worth saving, the Consumer Financial Protection Bureau and the Volcker Rule. The rest should be repealed.
Dodd-Frank is based on the fundamentally flawed premise of "we should give the financial regulators who failed to prevent the current financial crisis another chance to prevent a future financial crisis".
Why? Especially since the financial regulators have already shown themselves by not preventing the current crisis to be up to the task.
The upside of giving the financial regulators another chance is that they succeed in preventing the next financial crisis.
The downside of giving the financial regulators another chance is that they fail.
If they fail, who pays for their failure?
Are the Senators and Congressmen who drafted and voted for Dodd-Frank first in line with all of their net worth to pay? Is the President who signed Dodd-Frank into law first in line with all of his net worth to pay? Are the financial regulators who are suppose to have prevented the financial crisis first in line with all of their net worth to pay?
No. It is the taxpayers who pay when the financial regulators fail. I say "when" because the financial regulators have already shown they are prone to failure. It is only a question of time.
And it is the knowledge that the financial regulators will fail that drives individuals like Senators Brown and Vitter to propose legislation that attempts to protect the taxpayers from the failure of the financial regulators.
The Senators hope by putting more capital into the financial system this capital rather than the taxpayers' money will be used to pay for the losses incurred during the next financial crisis.
Of course, this won't work as financial regulators have already shown they will not use the banking system as it is designed and require banks to recognize upfront their losses on private and public debt that cannot be repaid.
Financial regulators don't require the banks to recognize losses upfront as the regulators perceive that any reduction in the reported level of capital signals a problem that threatens the safety and soundness of the financial system.
As regular readers know, this assumption is false as market participants already know the banks have experienced massive losses and undoubtedly have negative book capital levels if all their losses are realized. What market participants don't know is just how negative book capital levels really should be.
While I think that the goal of Senators Brown and Vitter to try to protect the taxpayer from the failure of the financial regulators is correct, their effort to put more capital into the financial system won't achieve this outcome.
Taxpayers would be much better off if Senators Brown and Vitter championed enforcement of the Securities Act of 1933 and requiring the banks to provide ultra transparency.
Under the Act, the government is suppose to ensure that market participants have access to all the useful, relevant information in an appropriate, timely manner so they independently assess this information and make a fully informed investment decision.
The current financial crisis has shown that the banks are "black boxes". It is only when the banks disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details that market participants have the information that they need to make a fully informed investment decision.
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