One regulation too few

Burdensome, costly, and—let’s face it—just plain stupid government regulation is all around us. And even well-meaning, reasonably well-designed regulations can impose costs all out of proportion with their benefits.

Consider the Family Educational Rights and Privacy Act (FERPA) (20 U.S.C. § 1232g; 34 CFR Part 99), a Federal law that has the admirable goal of protecting the privacy of student education records. My colleagues and I were recently informed by university officials that we may no longer leave corrected student assignments in a public place for them to pick up, because such materials are part of a student’s confidential record.

This would be a sensible rule if it applied only to exams, term papers, or other major assignments. However, the rule also applies to homework assignments which account for a trivial portion of a student’s actual course grade and are mostly just checked for completion. We will most likely devise a time-consuming work-around: generating random code numbers for each student and using those code numbers in place of names on all of their assignments. The alternative would be to return each problem set individually which, in a class of 100 students, would take too much time away from teaching and learning.

Making fun of these regulations, the politicians who make them, and the regulators and lawyers who make sure that they are adhered to is good sport—and the only compensation we get for putting up with them. Our distain for bad regulations, however, should not get in the way of recognizing that there are also good regulations.

Sadly, one of the good regulations—contained in section 716 of the Dodd-Frank Wall Street Reform and Consumer Protection Act 2010–was the victim of the Consolidated and Further Continuing Appropriations Act 2015, the trillion dollar spending bill signed into law by President Obama on 16 December 2014 in order to keep the US government running for a few more months.

Dodd-Frank was passed in the aftermath of the US subprime crisis. The text of the law is 848 pages long and contains a large number of provisions—some good, some bad, and some that have not yet been implemented. Section 716 of the law regulates “swaps,” one of the risker types of derivative securities which played an important role in the subprime meltdown. Known as the “Swap Push-out Rule,” section 716 prohibited institutions that dealt in these securities from receiving “federal assistance,” including advances from the Federal Reserve or FDIC insurance or guarantees.

In other words, if your institution got into trouble by dealing in these very risky securities, the feds would not bail you out with taxpayer money. Further, you could not pay for these securities by using money that you held—at very low cost–by taking federally insured deposits. Under section 716, banks had to “push out” these derivative out to affiliated—but uninsured—firms.

There has been a fair bit of fallout since the rule was revised. It has been alleged that the wording—originally contained in legislation passed by the House (but defeated in the Senate) last year—was written by bank lobbyists, in particular those on Citigroup’s payroll. Few lawmakers have been standing up to take credit for the latest attempt to revise section 716, although former Fed chair Ben Bernanke is on record as having supported some alteration to the regulation. Opponents of the revision come from the right and left, and include Senators Elizabeth Warren (D-MA), David Vitter (R-LA), and Sherrod Brown (D-OH). The White House opposed the measure, as did the Vice Chair of the Federal Deposit Corporation, former Federal Reserve Bank of Kansas City President Thomas Hoenig.

The amendment of section 716 is bad news for America’s future financial stability and the American taxpayer. Banks will now be able to use low-cost federally insured deposits to engage in risky swap transactions. And, when these transactions land them in trouble, they will be able to turn to the federal government to bail them out.

The problems generated by the revision of section 716 of Dodd-Frank can be reversed. All that is needed is for the authorities to force institutions that deal in these swap transactions to back them with enough capital to ensure that bank shareholders–and not taxpayers—will pay the price if the transactions sour. Given Congress’s willingness to throw section 716 overboard, such a reform is extremely unlikely.

Headline image credit: Money falling. CC0 via Pixabay.