Thursday, July 22, 2010

Financial Reform - Be Afraid

This is supposed to be a blog (mostly) about investment theory and practice, although really it admittedly wanders off-piste.You may have noticed it has veered more and more into the political realm of late. Sadly, this is because politics and the economy (and therefore investing) have become inextricably linked as the government continues to extend its reach almost everywhere.

Which brings me to the Dodd and Frank's "Wall Street Reform and Consumer Protection Act." It is 2300 pages long, and almost assuredly no one other than a few congressional lawyers and staffers have read it. As readers of this blog know, Johnston's Law asserts that unintended consequences rise with the square numbers of pages in a bill. And, already, on Day One we see our first, and it's a doozy: the shut down of the ABS market.

The Asset Backed Securities market is what funds car loans, credit card loans, and small business loans. It is vital to the functioning of our economy. It seems that the bill forces ratings agencies to accept liability for the quality of their ratings. Mind you, a rating is very clearly only an opinion, but the agencies will be placed in harm's way nonetheless (harm, in this case, being from the devil's minions in the plaintiff's bar).

So, the ratings agencies are simply saying, "screw this," and are refusing to rate ABS. The problem with that, though, is that many forms of ABS are required by law to be rated. Rut roh! This has led to an overnight shut down of the ABS market. Ford has already pulled a large auto loan offering.

Interestingly, the ratings agencies had no idea this was in the bill. It apparently wasn't in an earlier version. This underscores the fact that no one knows what's in it. Obama, who doesn't know the first thing about finance, certainly doesn't. Dodd and Frank? Please.

If Day One has led to the unexpected shut down of the ABS market, what will Day Two bring? Day One Hundred?


  1. Washington is so absurd and disconnected from the way things really work that it never ceases to amaze me. politicians think that spending and government intervention are the solution to everything.

    realistically, this bill will do nothing, as it was for the most part written by wall street lawyers, as most finance "reform" bills are. if anything, there are probably many key loopholes nestled somewhere inside the 2300 pages that will allow them to continue the practices that caused the problem, but on an even bigger scale than before.

    probably the best thing anyone could do would be to dissolve the federal reserve, as it is the main cause of many problems in the finance market, due to its willingness to release massive amounts of cash onto the market for low interest, this causing investment sprees such as the dot-com bubble, and the housing bubble.

    eventually, everyone comes to their senses and realizes that they assets they are paying absurd prices for aren't really worth that much. consequently, the gov steps in to prevent a "market crash" (ie: markets returning to realistic levels). Thus, the problem isn't corrected and the cycle continues.

    it doesn't help that many Americans are so ignorant to how things work and what is happening, allowing the cycle to continue.

  2. Follow up: the SEC did some scrambling yesterday and said that it's okay to issue ABS without a rating specified in the prospectus. Problem solved, more or less. But they HAD to solve this one, or the ABS market would have died. What about all the other problems in this bill that aren't quite so visible. Most will just add regulatory and legal to the financial industry (the plaintiff's bar is eagerly poring over the bill as we speak), which will, of course, be passed along to the broader economy (i.e. yuo and me).