John Paulson on Risks to Our Economy

This seems like a reasonable assessment to me.

John Paulson made three important points when he spoke to Les Echos, a French publication, recently.
1. Financial reform could hinder the recovery. It is text-heavy (2,000 pages!) and thought to be very difficult to implement. It was precipitated by an emotional reaction. The result is that it creates numerous conflicts and uncertainties. As Alan Greenspan says, I think it will create market distortions.
2. Inflation is a risk. Quantitative recovery is not without consequences and creates the potential for inflation. Currently we have no inflation because we still have overcapacity. But the risk exists. It is undeniable that this monetary expansion is equivalent to running the printing press. It remains to be seen whether the Fed will reduce the recovery before it becomes inflationary.
3. U.S. debt levels will sooner or later reach a "very serious" problematic threshold. There are serious uncertainties about the exit strategy of the Fed. I'd be very surprised if there was a third round of QE. While many economists believe that the U.S. debt remains at a manageable level, sooner or later it will reach a threshold that will be a problem. Today, our federal debt is still at a relatively reasonable (around 65% of GDP), but if we add the local debt of the States and local governments are approaching the level of 100% of GDP which begins to be close to that of Greece or Portugal. It is a very serious potential problem. The U.S. does not have the ability of unlimited borrowings.

Jeff Harding on FrankenDodd, Part 3

Regulation of Derivatives and ABS
Recall that one of the major themes behind the Act is that the “murky” world of “exotic” instruments such as credit default swaps and asset backed securities (ABS) added unacceptable risk to the financial system. The goal of the Act is to provide “transparency” and “accountability” for those engaged in such instruments.
The SEC and Commodity Futures Trading Commission (CFTC) will regulate derivative markets. The CFTC is involved because they regulate the futures and options markets which are included within definition of “derivatives.”
The new rules:

• Require securitizers of ABS to maintain 5% of the credit risk in assets transferred, sold, or conveyed through the issuance of ABS … The new rules must allocate the risk retention obligation between securitizers and originators. The retained risk may not be hedged. [The “skin in the game” rule.]
• Banks must spin off “riskier” swaps dealing activities but can still conduct such activities through separately capitalized affiliates.
• All standardized swaps must be cleared and exchange-traded.
• End users [i.e., those who use derivatives for actual commercial hedging purposes] are exempt from the clearing requirement …
• The banking regulators, the SEC and the CFTC, will set margin and capital requirements for uncleared swaps.
• Security-based swap dealers and major security-based swap participants will be required to comply with SEC-prescribed business conduct standards. … [They] will have a duty to communicate with counterparties in a fair and balanced manner based on principles of fair dealing and good faith and other standards and requirements prescribed by the SEC. [If you read The Big Short, you might say that this is the “Goldman Sachs Rule.”]
• It imposes new liability on securitizers for the underlying mortgages originated by third parties.

The Wall Street Journal ran an article exploring the world of farmers and futures contracts. Farmers rely on forward contracts to hedge their risks. What was interesting is the conclusion of the article: “There is no real understanding if the Act will exempt, say farmers who use futures as a hedge, or make it more difficult for them to hedge.”
Office of Credit Ratings
To regulate credit rating agencies, a new Office of Credit Ratings is established. The most significant outcome of the Act is that investors are allowed to sue the rating agencies. They are now treated like other “experts” such as lawyers and accountants and are subject to the same liabilities.
There are basically only three credit rating agencies, Standard & Poor’s, Moody’s Investor Service, and Fitch Ratings. They are referred to as Nationally Recognized Statistical Rating Organizations (NRSROs) under the Act. These private companies are sanctioned by the SEC and the Treasury to give credit ratings. A kind of monopoly if you will. Basically you can’t sell a security to the public without a rating from one of these companies.
When the rating agencies figured out what the legislation was doing to them, they promptly notified their clients that they couldn’t use their ratings in ABS securities registrations. That apparently put a halt to the ABS market and caused Ford to pull a pending offering. This caused the SEC to postpone the rules for six months until they figure out what to do.
This rule is actually a good thing in my opinion within the current regulatory structure. The failures of the rating agencies were part of the problem with the mortgage backed securities market. It is apparent that it wasn’t just that they didn’t understand the risk involved, rather they ignored it. If a lawyer gave an opinion that caused investors to lose money because of the lawyer’s negligence, the lawyer gets sued. Why not the rating agencies?
Office of Investor Advocate
A new Office of Investor Advocate is set up within SEC; plus there is an Investor Advisory Committee.
There are a number of provisions promoting “corporate democracy” such as allowing shareholders to nominated directors, to vote a non-binding resolution on executive pay and retirement packages, and establishes new rules governing corporate compensation committees. One of the aims of the legislation was to discourage corporations from paying “excessive” compensation to their executives, in the belief that it encouraged short-term thinking while sacrificing long-term stability.
The most significant rule is that the SEC is granted discretionary rule making authority to establish new standards of conduct for broker-dealers and investment advisers when providing personalized investment advice to retail customers. The concept is that the broker must act in the ”best interest of the customer without regard to the financial or other interest of the broker-dealer or investment adviser providing the advice.” This gets close to making broker-dealers act in a fiduciary capacity to its retail customers.
Bureau of Consumer Financial Protection
A new agency, the Bureau of Consumer Financial Protection, has the task of regulating consumer financial products such as, checking accounts, private student loans and mortgages. The agency will have the authority to “deal with unfair, abusive and deceptive practices.”
The new bureau will set standards for credit cards. Certain penalties are eliminated, reducing bank profits, which will raise costs for consumers in other areas. This has nothing to do with the bust, but rather is an exercise of power by the Democratic majority to impose politically popular “consumer friendly” rules that limit penalties that upset credit card users and borrowers.
New mortgage lending rules are established: prepayment penalties are limited, banks must lend on the basis of the borrower’s ability to repay, borrowers must submit more data showing they have the ability to pay, loan brokers and loan officers can’t be compensated for steering customers to a particular type of loan or rate, and new appraisal regulations establish rules on appraiser compensation.
A new Office of Housing Counseling is established within HUD. This new agency is described as follows:

The [Office] establishes rules necessary for counseling procedures, contributing to the distribution of home buying information booklets, carrying out functions regarding abusive lending practices relating to residential mortgages, providing for operation of the advisory committee, collaborating with community-based organizations with expertise in the field of housing counseling and providing for the building capacity to provide housing counseling services in areas that lack sufficient services

The creation of this agency is not encouraging. It is yet another wasteful bureaucracy within a vast federal structure.
The Act increases the requirement to qualify as an “accredited investor,” the kind of investor one must have to avoid SEC registration for private placements. Accredited investors must now have a $1 million net worth excluding the value of their primary residence, whereas the old rule was simply a $1 million net worth.
Federal Insurance Office
This is new. Generally insurance companies are regulated by the states. The reason many insurance companies incorporate separate entities in each state is to avoid federal regulation. But, while most regulation is still relegated to the states, a new Federal Insurance Office can step in and take over a company if it threatens “financial stability”:

The Act creates the Federal Insurance Office (FIO), the primary task of which will be to monitor insurance issues of national importance and give reports to the Secretary of the Treasury and Congress on such issues. The FIO also will advise the Secretary on major domestic and international insurance issues. …
The Act gives the FIO the authority to supervise … an insurance company, if material financial distress at the company or the activities of the company could pose a threat to the financial stability of the United States. An insurance company subject to the FIO’s supervision will be required to meet certain “prudential standards” concerning its operation. The prudential standards will be more stringent than those applicable to other nonbank financial companies that do not present similar risks to the nation’s financial stability.
The Act provides for the orderly liquidation of companies under the FIO’s supervision if it is determined that they should be put into receivership. The prudential standards concerning the operations of insurers under supervision will be in addition to, or instead of, state insurance regulations. The prudential standards may limit the ability of subject insurance companies to operate with the same level of freedom they now enjoy under the state-based regulatory regime. Overall, the states’ ability to regulate insurance companies under the FIO’s supervision may be more limited as a result of the Act.

Remember AIG? Nothing, it appears, is beyond the reach of federal control. Like other powers granted by the Act, the new FIO can basically regulate any insurance company it finds to be a threat to financial stability.
Regulation of Investment Advisors
Formerly mildly regulated private investment advisors are now required to file a statement with the SEC describing their activities. The law applies only to those advisers with $150 million under management. Private family offices are exempt.
Hedge Fund Regulation
Large hedge funds and fund advisers ($150 million plus) must “register” with the SEC. Many large funds already register so this will only affect the smaller funds.
Extraterritoriality of the Act
This is one of the aspects of the Act that seems to be passed over by commentators, but the Act grants the regulators the power to extend control over economic activity normally beyond the jurisdiction of the federal government. Gibson Dunn explains the new extraterritorial provisions of the Act as follows:

Securities markets are increasingly global with multinational companies listing securities for trading in the United States and with trading in U.S. securities occurring in overseas markets. At the end of its most recent term, however, the Supreme Court ruled that Section 10(b) of the Securities Exchange Act prohibited fraud only in connection with the purchase or sale of securities listed for trading on a domestic, United States exchange and did not extend to securities listed abroad but traded in the United States through American Depositary Receipts. Morrison v. National Australia Bank, N.A. ___ U.S. ___, No. 08-1191 (June 24, 2010).
Congress added provisions to the Act which restored the authority of the SEC and of the Department of Justice. In particular, the Act amended Section 22 of the Securities Act, Section 27 of the Securities Exchange Act, and Section 214 of the Investment Advisers Act to confer U.S. court jurisdiction over violations of the three anti-fraud provisions involving (i) conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors, or (ii) conduct occurring outside the United States that has a foreseeable substantial effect within the United States.

I am sure this new authority will be tested in the courts, and perhaps the Morrison case may give us hope these vague powers will be deemed unconstitutional, but the intent of the Act is to allow no foreign refuge.
The federal government’s extraterritoriality push is part of a larger move toward supranational regulation of financial companies. Since the 2008 crash, countries have been meeting under the auspices of the Bank of International Settlements to discuss international financial stability. One of the outcomes of these efforts will be the new Basel III requirements regarding bank capital and liquidity structures. For example, the minimum Tier 1 leverage ratio for banks worldwide will be 3%.
Is Your Gold Conflict Free?
The Act condemns ‘conflict’ minerals from the Democratic Republic of the Congo, and as such the SEC will draft rules to assure a conflict free chain of custody to prove they are not from sources deemed exploitative such as local warlords. The minerals include gold which is produced by artisanal miners in certain areas. The SEC will produce a map of Congo to aid buyers.

Jeff Harding on FrankenDodd, Part 2

Assumptions Guiding the Act
The Act is guided by several broad concepts:

1. Wall Street must be strictly regulated to prevent systemic risk and to promote financial stability.
2. Large interconnected international financial companies are inherently risky.
3. Excessive leverage leads to systemic risk.
4. A lack of transactional transparency impeded necessary regulatory control.
5. Investors lacked information to properly understand the nature of complex risky securities.
6. Regulators are capable of carrying out the intent of the Act.

Specific blame for the financial collapse is assigned as follows:

Lenders, investment bankers, credit-rating firms, mortgage brokers and others had ample incentive to take risks, often with other people’s money. That led to a bubble in credit: too much borrowing.
The explosion of trading in the shadowy worlds of derivatives and hedge funds hid risks, and perhaps even created new ones, without the transparency essential to well-functioning markets.
Big financial firms lacked sufficient capital cushions to withstand a shock, and assets they could sell quickly to raise needed cash. …
For the inevitable day when another big financial firm gets into trouble, the bill attempts to impose order and punishment—but gives authorities the power to use taxpayer money if they deem it necessary. …

Description of the Act
What is obvious from a review of the Act is that the powers granted are very broad, almost unlimited, ill-defined, and yet to be written. The following descriptions of the Act are intended to give you an idea as to the vast scope of the Act and the powers granted. I have picked out some of the more important powers, but the Act is much more invasive and controlling than what I am describing here. I have gone into some detail because I believe that most people don’t understand how pervasive the Act is. Please bear with me here; it will be eye-opening.
Here is a major law firm’s (Gibson Dunn) overview of the Act:

[The Act] … seeks to increase financial marketplace transparency and stability by establishing a Financial Stability Oversight Council (the “Council”) focused on identifying and monitoring systemic risks posed by financial firms and by financial activities and practices. It establishes a new regulatory and supervisory framework for “large, interconnected” banking organizations and certain nonbank financial companies. By a two-thirds vote, the Council can determine which U.S. and foreign nonbank financial companies that are predominantly engaged in financial activities (together “NBFCs”) are to be subject to enhanced supervision (“Supervised NBFCs”) by the [Fed], based on the perceived risk a company poses to financial stability in the United States. Empowering the Fed to implement this regime substantially enhances its powers and responsibilities.

As you will see, the Act, while it comprises 2,300 pages, speaks mostly of legislative goals, with specific requirements that require fleshing out by rules and regulations that will follow. For the most part, the actual law will be developed by the mandarins.
The Concept of Financial Risk
The entire Act is built around the concept of protecting the “financial stability” of the economy. The term “financial stability” is mentioned about 80 times in the Act but there is no definition of what it is. The Act assumes that the Council will know it when it sees it.
Instead of defining the term, the Act assigns the new Financial Stability Oversight Council the duty of regulating companies whose activities threaten “financial stability.” The Council is obligated to conduct studies and make findings on which to base new rules and regulations which establish “prudential standards” for regulated companies. It is assumed that out of that process “financial stability” will be defined, but it seems no one really knows what “financial stability” is or what consists of a threat to it. Which is a problem is when you give vast powers to a new agency: it makes their powers almost unlimited.
The likelihood of finding this Act unconstitutional because of vagueness is low. Consider the fact that a Council takeover of a company because it is a “threat to financial stability” will probably only be challenged in the courts during a financial crisis. This puts pressure on judges who have little knowledge of economics. They would be afraid to assume responsibility for the economy. Since the experts testifying in court will most likely be mainstream economists and financiers who believe in current economic thinking that such powers are necessary to save the economy, it is unlikely that courts will believe the testimony of “outliers” such as Austrian theory economists.
The Act thus creates a board of economics czars who will have almost unlimited powers to regulate the financial sector of the economy.
Financial Stability Oversight Council
The Act creates a council of regulators, the Financial Stability Oversight Council, to monitor and regulate companies it believes have the ability to jeopardize financial stability. It is to be chaired by the Secretary of the Treasury. The Fed ends up as the primary regulator of financial firms and oversees the Council.
The idea is to prevent big “interconnected” banks and other large financial institutions such as hedge funds, investment banks, and insurance companies, from blowing up again. The extension of federal power to regulate nonbank financial institutions is a major expansion of federal authority.
The Council has the power to seize and break up financial firms whose collapse would put the economy in danger (“threaten the financial stability of the economy”). The Fed has the responsibility to decide whether the Council should vote on breaking up big companies. A position of a second Fed vice-chair is established to supervise financial firms; the White House appoints him or her (they have nominated Janet Yellen).
How the Rules Will Be Determined
The Council is given the following duties:

1. Collect information from member agencies and other regulators, and research the issues.
2. Adopt comprehensive regulations to control financial institutions.
3. Monitor the financial services marketplace to identify potential threats to U.S. financial stability.
4. Monitor domestic and international financial regulatory proposals and developments, including insurance and accounting issues.
5. Advise Congress and make recommendations that will enhance the integrity, efficiency, competitiveness, and stability of the U.S. financial markets.
6. Facilitate information sharing and coordination among the member agencies and other federal and state agencies regarding domestic financial services policy development, rulemaking, examinations, reporting requirements, and enforcement actions
7. Recommend general supervisory priorities and principles.
8. Identify gaps in regulation that could pose risks to U.S. financial stability.
9. Require supervision by the Fed for nonbank financial companies that may pose risks to U.S. financial stability in the event of their material financial distress or failure, or because of their activities.
10. Make recommendations to the Fed concerning the establishment of heightened prudential standards for risk-based capital, leverage, liquidity, contingent capital, resolution plans and credit exposure reports, concentration limits, enhanced public disclosures, and overall risk management for big interconnected banks and big financial institutions.
11. Identify systemically important financial market utilities and payment, clearing, and settlement activities.
12. Make recommendations to primary financial regulatory agencies to apply new or heightened standards and safeguards for financial activities or practices that could create or increase risks of significant liquidity, credit, or other problems spreading among big banks and other big financial institutions and U.S. financial markets.

Within 9 months they must adopt new regulations which must include:

1. regulations implementing the permitted transactions provisions and any limitations on permitted transactions.
2. regulations imposing additional capital requirements and quantitative limits (including diversification requirements) on permitted activities if the Regulators determine these limitations are appropriate to protect safety and soundness of banking entities engaged in permitted activities.
3. regulations setting the ownership level in a fund that is “immaterial to the banking entity” which in any event cannot be more than 3% of the banking entity’s own tier 1 capital [Volcker Rule]. The Volcker Rule will apply to any entity deemed to be systemically important nonbank financial companies
4. regulations regarding internal controls and record keeping to insure compliance with the Rule.
5. rules determining what “similar funds” are to be included in the definition of “hedge fund” and “private equity fund.”
6. rules defining the full extent of the definition of “trading account” for purposes of purposes of determining the scope of prohibitions on proprietary trading.
7. rules defining additional securities that, if traded by a covered entity as a principal for its own trading account, constitute proprietary trading.
8. rules defining additional accounts that count as “trading accounts” for purposes of determining the scope of the prohibition on proprietary trading.

Financial Institution Rules
Some of the key rules that apply to large ($50+ billion) interconnected financial companies include:

1. The new “prudential standards” to be adopted by the Council may “differentiate” among companies, which means the Council can set “heightened standards” for some companies but not others, as they see fit.
2. The new “prudential standards” may include risk-based capital requirements, leverage limits, liquidity requirements, resolution plan and credit exposure report requirements, concentration limits, a contingent capital requirement, enhanced public disclosures, short-term debt limits, and overall risk management requirements.
3. The Council can limit a company’s leverage (i.e., debt to equity ratio) to 15 to 1, or less, if the company is found to pose a “grave threat to financial stability.”
4. A new requirement requires regulated companies to “maintain a minimum amount of long-term hybrid debt that is convertible to equity in times of financial stress“ (”contingent capital”). In essence, the Council can require a company to convert this debt to equity in the event of a financial crisis. The Council has 2 years to study this and then tell us what this means.
5. Regulated companies cannot have a credit exposure to a single unaffiliated firm that exceeds 25% of its capital and surplus.
6. The “Volcker Rule” requires banks to limit proprietary trading to 3% of Tier 1 capital; they will have 7 years or longer to wind down such investments. The purpose of the rule is to restore “the Glass-Steagall barrier between commercial and investment banks” and to “update that barrier to reflect the modern financial world and permit a broad array of low-risk, client-oriented financial services.” In other words, banks, for the most part, will be more like utilities.
7. A bank or a “systemically important nonbank financial company” is prohibited from acquiring or retaining any ownership interest in or sponsoring a hedge fund or private equity fund.
8. Regulated companies cannot acquire any company with $10 billion or more in assets without giving the Fed prior notice.
9. Banks must write “living wills” which is a roadmap for dissolution if seized by the government.
10. Judicial review of a decision to subject a nonbank financial institution to the Council’s authority is limited to a finding that the decision was not “arbitrary and capricious.”
11. To commence an “Orderly Liquidation Authority” (i.e., seizure of a financial institution determined to be in default or about to default), the Council must petition the D.C. District Court. The government only has to prove that (i) the company is in default or about to default, and (ii) the decision was not “arbitrary and capricious.” If the court fails to act within 24 hours of receiving the petition, the order goes into effect. The company affected may appeal the decision to the D.C. Court of Appeals, but the grounds of appeal are limited to the same findings as in the District Court. Once the petition is granted, the case proceeds similar to bankruptcy case.
12. Do you recall President Obama’s promise that we taxpayers will never have to pay for bailouts again? That is not true, and they have found a way around unpopular bailouts. According to the Act, while the Fed cannot lend to specific companies it can lend as much as needed to “economic sectors”.
13. Ron Paul’s efforts to gain oversight of the Fed were largely ignored, but the Act does prise open a small crack by allowing the GAO to audit certain emergency actions and the Fed must disclose the details of certain loan activity.

The Financial Stability Oversight Council has the power to do almost anything and there is very limited judicial review of their decisions. They justify these vast powers on their belief that they are necessary to protect the economy.

Jeff Harding on FrankenDodd, Part 1

Part 1 by Jeff Harding of the Daily Capitalist blog:

Until I began to examine the Dodd-Frank financial overhaul bill I had no idea that it would so significantly change the direction of the United States. It’s scope is so vast and pervasive that it is difficult to grasp its totality. I wrote this article to try to explain this and why I believe it is so important for us to understand it. Because of its complexity it was not possible to do this briefly, so I wrote this major “white paper” and divided it into four parts to make it easier to digest. Please stick with me for the next four days; your eyes will be opened.

Part 1

The new financial overhaul bill is the greatest government takeover of the financial sector of the economy since the National Recovery Act of 1933 when Franklin Roosevelt attempted to introduce central planning in America.
More than just a new law, the Dodd-Frank “Wall Street Reform and Consumer Protection Act” (the “Act”) gives government a relatively free hand to set prices and wages, to make business decisions, to promote or eliminate businesses, and to break up businesses. It establishes a large new bureaucracy to enable the government to dictate its wishes to the industry.
A major law firm described the Act as follows:

The Act marks the greatest legislative change to financial supervision since the 1930s. This legislation will affect every financial institution that operates in this country, many that operate from outside this country and will also have a significant effect on commercial companies. As a result, both financial institutions and commercial companies must now begin to deal with the historic shift in U.S. banking, securities, derivatives, executive compensation, consumer protection and corporate governance that will grow out of the general framework established by the Act. While the full weight of the Act falls more heavily on large, complex financial institutions, smaller institutions will also face a more complicated and expensive regulatory framework.

The Act isn’t directed just at the financial sector; because of its vast scope, it is directed against everyone.
Startling as it may seem, the Act does nothing significant to prevent the real causes of this or any future boom-bust cycle. At best one may analogize this as the doctor breaking the thermometer to cure a fevered patient. At worst it is a massive federal power grab which will inhibit financial innovation, increase the cost of money, and open wide the gates to a favored few where politicians, politics, and lobbyists, rather than markets, determine the direction of the financial sector of America’s economy.
While the new law has been signed by the President, it has not yet been written. That task will be the job of federal mandarins, the career lawyers and economists inside and outside of government who live off of government regulation. As such the ultimate consequences of this Act are unknown and will not be fully known until years later after the regulations have been written, agencies are established, and power is distributed among the bureaucrats. In other words, the Act’s advocates have no idea how the new law will impact the economy.
The ‘Failure of Capitalism’
The Act assumes that the economic bust was caused by a failure of capitalism and a failure of government to properly regulate the economy.
Upon signing the Act, President Obama said:

“For years, our financial sector was governed by antiquated and poorly enforced rules that allowed some to game the system and take risks that endangered the entire economy,” Mr. Obama said.
The new law, he said, would better protect consumers, empower investors and bring transparency to dark corners of the financial markets.
“The American people will never again be asked to foot the bill for Wall Street’s mistakes,” Mr. Obama said. “There will be no more taxpayer-funded bailouts. Period.”

The President and most politicians, Republicans and Democrats, blame the crisis on capitalism itself, and, rather incredibly, on what they view as unregulated “laissez-faire” capitalism. They ignore the fact that the financial industry is one of the most regulated sectors of our economy. When they say “laissez-faire” what they really mean is that they want to completely control the financial sector.
The President views Wall Street and free enterprise with disdain, repulsed by what he sees as just the latest failure of capitalism and the “old ways and failed policies of yesterday.” He believes, as the benevolent legislator-in-chief, he must step in and protect us from evil predations of Wall Street like a shepherd guarding his flock: only the guiding hand of government can make capitalism safe for society.
The President, like most politicians, lawyers, and economists, believes that the economic bust was caused by greed, excessive compensation, fraud, speculation, complex securities that no one understood, predatory Wall Street practices, and a lack of sufficient regulatory powers. These factors, they say, allowed financial institutions to take unnecessary risks which jeopardized the world’s financial system and almost brought it down.
The problem is that their beliefs are wrong and they make up data to fit their beliefs. Their conventional wisdom fails to satisfactorily explain the actual underlying causes of this boom-bust cycle and the new law will do nothing to prevent another cycle. The factors they blame for the crash always exist in financial markets, and yet, for reasons they do not explain, actors on the financial stage suddenly explode into an orgy of greed directed at the housing market.
There are two questions you should consider while evaluating the Act’s impact and scope that help explain this boom-bust cycle:

1. Why did the housing market become a bubble?
2. Why would any lender lend money to a home buyer who (i) had a credit score of 500, (ii) made a down payment of 5% or less, and (iii) didn’t have to prove his or her ability to repay?

I would answer these questions by saying:

1. Only cheap money drives bubbles and there is only one entity that creates cheap money and that is the Federal Reserve—from 2000 to 2004 the Fed Funds rate went from 6.5% to 1.0% wildly distorting entrepreneurial behavior. This was the cause of this boom-bust cycle.
2. No one would lend so carelessly unless they didn’t care. They didn’t care because someone else, in this case the government (Fannie, Freddie, and the FHA), would guarantee repayment.

Everything stems from these two factors yet there is nothing in the Act that prevents the Fed from starting a new cycle or that prevents Fannie or Freddie from again distorting the economics of the housing market. The purpose of this article is not to go into the ultimate causes of the bust as I have discussed them at length in other articles, but these factors highlight the foundational fallacies of the Act.
The Act’s Timing
This chart gives a good picture of the timing for implementing the Act:

This process is described as follows:

Now, the legislation hands off to 10 regulatory agencies the discretion to write hundreds of new rules governing finance. Rather than the bill itself, it will be this process—accompanied by a lobbying blitz from banks—that will determine the precise contours of this new landscape, how strict the new regulations will be and whether they succeed in their purpose. The decisions will be made by officials from new agencies, obscure agencies and, in some cases, agencies like the Federal Reserve that faced criticism in the run-up to the crisis.
The Commodity Futures Trading Commission has designated 30 “team leaders” to begin implementing its expansive new authority over derivatives, and has asked for $45 million for new staff. The Federal Reserve, Federal Deposit Insurance Corp. and Securities and Exchange Commission are also in the thick of the implementation.

Law firm Davis Polk Wardwell calculated the number of agencies involved in the rule making process. In the below chart, the “Bureau” is the Bureau of Consumer Financial Protection, the “Council” is the Financial Stability Oversight Council, and the “OFR” is the Office of Financial Research:

Here is the reality: it will take many more years to write and implement the regulations which really define the Act. It may be that some of these regulations will never be written, something that is not unheard of in Washington.
The Act will be a siren call to lobbyists, lawyers, accountants, and economists.
Regime Uncertainty and Perfect Wisdom
The initial impact of any new and unwritten law is uncertainty, and uncertainty is what business abhors. “Regime uncertainty,” a concept developed by economist Robert Higgs, says that such legislation causes businesses to pause expansion until they know how the law will affect them. This is apparently already happening:

The timing of Dodd-Frank could hardly be worse for the fragile recovery. A new survey by the Vistage consulting group of small and midsize company CEOs finds that “uncertainty” about the economy is by far the most significant business issue they face. Of the more than 1,600 CEOs surveyed, 87% said the federal government doesn’t understand the challenges confronting American companies.

Yet Treasury Secretary Timothy Geithner believes they can regulate us with perfect wisdom:

Treasury Secretary Timothy Geithner vowed the Obama administration would try to avoid choking off economic growth as it implements the financial-regulatory overhaul enacted last month and pursues new reform measures.
In his first public appearance before Wall Street executives since the Dodd-Frank bill was signed July 21, Mr. Geithner said the administration would eliminate old “rules that did not work” even as federal agencies are writing the more than 200 new rules required by the regulatory overhaul.
Mr. Geithner said the changes were needed to curtail “too much freedom for predation, abuse and excess risk,” but said it should still seek to “safeguard the freedom, competition and innovation that are essential for growth.”

Mr. Geithner believes in the “just right” Goldilocks philosophy of regulation. I question that any central planner would have the wisdom to supplant the decisions of millions of economic actors without negative consequences. One might say this is a form of arrogance associated with (almost) absolute power.
‘Some Provisions of the Act Are Good’
When we evaluate the Act it would be a mistake to look at its individual parts rather than its whole. To look at one provision and say, “well that sounds reasonable” is a form of political diversion that only serves to obscure the fact that the thousands of provisions in this Act taken together vastly enlarge the power of the federal government and reduce individual freedom. That cannot be good.
I will say that some of the provisions, in light of the Wall Street-Washington Financial Complex’s system of crony capitalism, may actually reduce some risk that we taxpayers will eventually have to pay for. But that ignores the power and influence of Wall Street and its friends within government to influence rule-making to suit their needs (“regulatory capture”).
This revolving door between Washington and Wall Street allows people attracted to power and who are skeptical of the ideals of a free market, to dominate economic policy for their benefit. One way to say this is that it creates a partnership between the financial sector of the economy and the government (which is the controlling partner in this relationship). In the 1930s this type of political system was greatly admired in Washington. Today this system has evolved into “crony capitalism,” an oligarchic structure maintained by the Wall Street-Washington Financial Complex to perpetuate itself.

Thanks, Congress, for Higher Bank Fees!

Free checking, a banking mainstay of the last decade, could soon go the way of free toasters for new account holders. Banks are already moving to make up the revenue they will lose on lower overdraft and debit card transaction charges by raising fees on other services.
Banks like Wells Fargo, Regions Financial of Alabama and Fifth Third of Ohio, for instance, recently began charging new customers a monthly maintenance fee of $2 to $15 a month — as much as $180 a year — on the most basic accounts. Even TCF Financial of Minnesota, whose marketing mantra championed “totally free checking,” started imposing fees this year in anticipation of the new rules.
To be sure, in many cases customers can escape the new checking account charges by maintaining a minimum balance or by using other banking services, like direct deposit for paychecks and signing up for a debit card.
Still, with checking account fees spreading, Bank of America rolled out a fee-free, bare-bones account on Wednesday, the eve of the Senate vote. The catch? To avoid any charges, customers must forgo using tellers at their local branch, use only Bank of America cash machines, and opt to receive only online statements.

Finance Reform Bill Empowers Unions and Environmentalists, Advances Progressive Agenda, Hiring Quotas

The financial reform bill expected to clear Congress this week is chock-full of provisions that have little to do with the financial crisis but cater to the long-standing agendas of labor unions and other Democratic interest groups.
Principal among them is a measure to make it easier for unions, environmental groups and other activist organizations that hold shares to put their representatives on the boards of directors of every corporation in the United States.
The so-called "proxy access" provision, which activist groups say they will use to try to improve oversight of corporate financial practices, has provoked a backlash from the Business Roundtable, U.S. Chamber of Commerce and other major non-Wall Street business groups.
"This legislation includes provisions totally unrelated to the financial crisis which may disrupt Americas fragile economic recovery" and lead to increasing political battles in the boardrooms, said John J. Castellani, president of the roundtable.
Business groups are also rankled that the legislation would impose costly new burdens on airlines, utilities and other non-financial businesses that were victims rather than villains in the crisis, simply because they use financial derivatives to hedge their businesses against risks such as fluctuations in oil prices, interest rates and currencies.
Such hedging practices played no role in the crisis, though they helped many businesses weather the financial turbulence and recession that followed in the aftermath of the Wall Street storm.
Other provisions of the financial legislation, which goes before the full Senate on Thursday for a vote and likely passage, favor Democratic constituencies directly by requiring banks and federal agencies to hire and do more business with them.
The bill would create more than 20 "offices of minority and women inclusion" at the Treasury, Federal Reserve and other government agencies, to ensure they employ more women and minorities and grant more federal contracts to more women- and minority-owned businesses.
The agencies also would apply "fair employment tests" to the banks and other financial institutions they regulate, though their hiring and contracting practices had little or nothing to do with the 2008 financial crisis.
"The interjection of racial and gender preferences into America's financial sector deserves greater media exposure" before Congress debates and passes the massive 2,400-page bill, said Kevin Mooney, a contributing editor for Americans for Limited Government's daily newsletter.
The powerful new consumer protection agency that is the centerpiece of the reform bill also would provide substantial employment opportunities and funding for Democratic and social-activist groups such as the Association of Community Organizers for Reform Now (ACORN), critics say.
Rather than focus on the abuses in the mortgage-lending market that led to the crisis, the new consumer agency would have broad-ranging powers to regulate and punish virtually any company that has a financial relationship with consumers - even those that had nothing to do with the crisis, said Sen. Richard C. Shelby, Alabama Republican.
Mr. Shelby, the ranking member of the Senate Banking, Housing and Urban Affairs Committee, sought to craft a more tailored role for the agency in weeks of negotiation over the Senate bill.
"During our negotiations on the consumer bureaucracy, my Democrat friends were not focused on the mortgage market. Their sights were set on the rest of the economy," he said. "The new bureaucracy is an enormous reach across virtually every segment of our economy, and a massive expansion of government influence in our daily financial lives."
Sen. Bob Corker, a Tennessee Republican who also sought to help write a bipartisan Senate bill more narrowly focused on the problems that led to the crisis, said he fears that an activist director of the consumer agency could use agency power to direct loans to favored constituencies, regardless of whether the loans are sound or pose risks to the banking system.
"This may sound a little far-fetched, but you can have the wrong person in this position - there's no board, there's really no check and balance - that you can imagine could use this organization to try to create social justice in the financial system," he said.
Like the corporate boardroom provisions, many of the activities within the reach of the new consumer agency had "absolutely nothing - zero - to do with the financial crisis," Mr. Corker said. "But this has become a Christmas tree for those kinds of things, because people realize it's something that's going to pass."

Finance Reform Bill Will Send Terrible Ripples Through Ag Community

This is what happens when politicians run amok! 

GILTNER, Neb.—Farmer Jim Kreutz uses derivatives to soften the blow should the price of feed corn drop before harvest. His brother-in-law, feedlot owner Jon Reeson, turns to them to hedge the price of his steer. The local farmers' co-op uses derivatives to finance fixed-price diesel for truckers who carry cattle to slaughter. And the packing plant employs derivatives to stabilize costs from natural gas to foreign currencies.
Far from Wall Street, President Barack Obama's financial regulatory overhaul, which may pass Congress as early as Thursday, will leave tracks across the wide-open landscape of American industry.
Designed to fix problems that helped cause the financial crisis, the bill will touch storefront check cashiers, city governments, small manufacturers, home buyers and credit bureaus, attesting to the sweeping nature of the legislation, the broadest revamp of finance rules since the 1930s.
Here in Nebraska farm country, those in the business of bringing beef from hoof to mouth are anxious, specifically about the bill's provisions that tighten rules governing derivatives. Some worry the coming curbs will make it riskier and pricier to do business. Others hope the changes bring competition that will redound to their benefit.
"Out here we like to cuss the large banking institutions because of the mortgage mess, but we also know that without them some of these markets don't work," says Mike Hoelscher, energy program manager for AgWest Commodities LLC, a Holdrege, Neb., brokerage that provides derivatives services to the farming industry.

Derivatives are financial instruments whose value "derives" from something else, such as interest rates or heating-oil prices. The first derivatives were crop futures, which appeared in the U.S. at the end of the Civil War and became a standard facet of business for companies across America.
During the financial crisis, they became notorious as American International Group Inc. and others were gutted by bad bets on derivatives linked to bad mortgages.
President Obama and other proponents say the financial overhaul will prevent the kind of reckless lending and borrowing that sank the financial system and left taxpayers with the check. They say non-financial companies are worrying unduly about the derivatives portion of the legislation. The Senate is expected to approve the financial regulatory overhaul on Thursday, sending it to the president.
The full impact won't be known for years, but in Nebraska nerves are already on edge.
Executives at Five Points Bank in Hastings think the new rules on mortgage lending will make the home-loan business less profitable. "When they create a new regulator, it really scares us," says Nate Gengenbach, vice president of commercial and agricultural lending.
Advance America Cash Advance Centers Inc. thinks the new Bureau of Consumer Financial Protection will take aim at the payday-loan business, though it's not clear what steps the agency will take. Advance America's storefront at the Skagway Mall in Grand Island charges an effective 460.08% annualized interest rate on a two-week $425 loan.
But it's the derivatives portion—the part of the bill aimed directly at Wall Street—that might end up touching most lives in rural America.
The new law requires most derivatives transactions be standardized, traded on exchanges, just like corporate stocks, and funneled through clearinghouses to protect against default.
Faced with intense lobbying, Congress partially exempted businesses that use derivatives for commercial purposes. So, farmers and co-ops probably won't face new collateral requirements, for instance—although there remains a dispute over that section of the bill. Those that trade derivatives on regulated exchanges, such as the Chicago Board of Trade, are less likely to see immediate impacts than those conducting private over-the-counter deals, which will face federal regulation for the first time. The goal is to make such deals transparent.
The question for these farmers is whether such rules will make hedging more expensive. Some say new requirements on big players will create higher costs for small players, including the cash dealers will have to put aside to enter into private derivatives transactions. Some brokers think restrictions on big-money banks and investors will drain the amount of money available to the everyday deals farmers favor.
Others predict the opposite effect, pushing money from the private market to the exchanges and creating more competition that will benefit farmers.
Uncertainty reigns in Giltner, a town of 400 residents 80 miles west of Lincoln. At first glimpse, Giltner's landscape seems featureless, a fading horizon of corn and soybeans. But its details are more subtle, including wildflowers and shaded creeks. Everywhere galvanized-steel sprinkler systems crawl across farm fields like giant stick insects.
Mr. Kreutz, an outgoing 36-year-old with a sandy crewcut and sunburned neck, gave up a career in finance and took over the 2,800-acre family farm after his father's death. As he works his fields, he checks the crop futures prices on his smart phone.
Here's how Mr. Kreutz does it: Say in early summer he sees that the price for a Chicago Board of Trade futures contract on corn for delivery later in the year is $3.56 a bushel. If he likes the price, and wants to lock it in, he calls AgWest and sells a futures contract for 5,000 bushels. The futures contract is a derivative in which the price for corn is set now for exchange in the future, though no kernels will change hands. Instead, when the contract nears expiration, Mr. Kreutz and the buyer of his contract will settle—in effect—by check.
By fall, when Mr. Kreutz is ready to deliver his crop to the local co-op, the market price might have fallen by 50 cents. He'll sell his actual corn for that lower amount. But he'll make up the difference through his financial hedge. (Mr. Kreutz buys a new futures contract at the lower price to make good on his earlier promise, making up the 50 cents.) In all, he'll have hit the price target he locked in earlier in the year, minus brokerage fees.
If the price rises during the summer, as it did during the food crisis two years ago, Mr. Kreutz has to pony up extra cash for his broker—a margin call—to maintain his positions. He recoups that by selling his actual corn at a higher price, but has to take a loss to meet the futures contract he signed earlier in the year, missing out on a windfall but ultimately meeting his target price.
Mr. Kreutz does this type of operation dozens of times a year, hedging about 70% of his 345,000-bushel corn harvest.
Such deals ripple through the local economy. When Mr. Kreutz gets a margin call from his broker, he turns to his banker, Mr. Gengenbach, for a loan to cover it. Mr. Gengenbach estimates that one quarter of his farm clients use derivatives.
"Somebody like Jim has a lot of money in his crop out here," says the 37-year-old Mr. Gengenbach. "If he can't protect that, it's not good for us."
Mr. Kreutz's brokerage, AgWest, thinks the new finance law will hurt both firm and farm. If big investors and dealers have to keep more cash on hand, there will be less liquidity in the market and therefore the cost of derivatives will increase, Mr. Hoelscher, the broker said.
A few minutes from the Kreutz family farm are the corrals of Jon Reeson's feedlot. Mr. Reeson, 43, is married to Mr. Kreutz's sister Jane. His feedlot holds as many as 1,500 steer, mostly Black Angus, which grow from 600-lb. calves into 1,300 pounders ready for slaughter.
Mr. Reeson uses derivatives to hedge both the price he pays for feed and the price he gets for selling his steer.

The fattening takes about 7,000 pounds of food for each animal. Mr. Reeson can't count on a favorable price from his brother-in-law's farm, in which he has a stake, so when he sees a feed price he likes, he seals it with a futures contract.
In April, he called AgWest and locked in a price with a futures contract for $95 per hundredweight of cattle. Since then the market price has dropped to $90. If the price stays there until October, he'll have made the right call, earning a higher price than if he'd relied on the market alone. If the price spikes higher, though, he'll miss out on potential gains.
Mr. Reeson is willing to live with that possibility in exchange for locking in a profit or a narrowed loss. Derivatives hedging helped him survive the recession of 2008-2009, when cash-strapped diners avoided steak and the price of beef plunged.
He's watching the new legislation warily and can't yet tell if it will hurt or help.
When his cattle have reached full weight, Mr. Reeson puts them on Roger and Barb Wilson's trucks for the trip to the slaughterhouse. The Wilsons have seven semi tractors and 16 trailers, and one of their biggest costs is diesel fuel to keep the fleet on the road.
In 2004, Cooperative Producers Inc., his local co-op, offered Mr. Wilson a price-protection plan for 10,000 gallons of diesel at about $2.50 a gallon, with 90 days to use it.
CPI had a choice. It could take its chances and hope the price of fuel would drop before Mr. Wilson took delivery on his full order, a windfall for the co-op. If diesel prices jumped, though, the coop would take a bath. "That falls under speculation," says Gary Brandt, CPI's vice president of energy. "But that's not what cooperatives do. That's what Goldman Sachs does."
Instead, CPI hedged on the New York Mercantile Exchange, buying a futures contract on heating oil, a close market substitute for diesel fuel. The co-op goes a step further and hedges also the difference between the prices of fuel traded in New York and delivered in Nebraska.
For the 57-year-old Mr. Wilson, the pricing plan proved a mixed blessing. The first year, the pump price shot up by another 20 to 25 cents, meaning he was getting a good deal. The following year the pump price dropped about a quarter a gallon, but Mr. Wilson was obliged to pay the higher price. "It hurt to have to pay for that fuel," he recalls sourly. He quit the program after that.
The finance law's imminence has prompted CPI's Mr. Brandt to warn his sales team and customers that the co-op may have to end its maximum-price fuel contracts. He's worried too that CPI might have to cut its fuel supplies if it can't hedge against price drops.
"We have to start making a game plan if they take away the ability for us to hedge that inventory," Mr. Brandt says.
The Wilsons deliver Mr. Reeson's steer to a low, cement-gray complex on the edge of Grand Island, Neb., where trucks arrive loaded with cattle, and others leave loaded with meat. Over the past year, Mr. Reeson has sold 1,125 steer to the packing plant, which is owned by JBS USA, a Greeley, Colo., unit of Brazilian-owned JBS SA.
JBS buys livestock two ways. Sometimes it pays cash for the following week's kill. Sometimes it buys further forward, agreeing in July, for instance, to a fixed price for steer delivered in December. JBS hedges on the derivatives market to make sure live cattle prices don't drop before it takes delivery.
The company also sells beef cuts forward to restaurant chains, promising delivery at set prices months ahead of time. JBS expects to have enough meat to fulfill the agreements. But if it runs short, it doesn't want to risk having to pay higher prices to buy meat to supply those restaurants.

So, it uses the derivatives market to play it safe. To do so, the company has to find a way to hedge different cuts of beef: Tenderloins might represent 1.5% of the total value of a steer. Strip loins might make up 3%. In a sense, JBS protects itself by reconstructing the steer through a derivatives trade on the Chicago Mercantile Exchange. "We try to put the carcass back together financially," says company spokesman Chandler Keys.
The company hedges electricity for its refrigerators and natural gas for its boilers. It hedges currencies to stabilize its income from overseas. It hedges fuel for its fleet of thousands of trucks.
Even executives at a big firm such as JBS haven't been able to nail down the precise impact of the legislation on their business, introducing an unaccustomed level of uncertainty into their operations. They aren't changing the way they use derivatives, yet, hoping instead that exemptions for commercial users will insulate them.
"To get food, particularly highly perishable food like meat and poultry, through to the consumer, you have to manage your risk," says Mr. Keys.