A Falling Tide Reveals A Lot Of Things

J. Kennerly Davis, Jr.

Warren Buffett, the world famous investor and head of Berkshire Hathaway, has enlivened the public dialogue with many memorable quotes over the years spanned by his highly successful career. Perhaps his most famous quote emerged from the 1994 annual shareholders meeting of Berkshire Hathaway.

While discussing the inevitable day of reckoning that follows every period of financial excess, Buffet said, “Only when the tide goes out do you learn who’s been swimming naked.” Only when periods of easy money, unsustainable debt, and asset bubbles come to an end do we see who has and has not invested wisely, managed competently, and governed responsibly.

Now, as the Federal Reserve steadily raises interest rates in an effort to slow the destructive inflation unleashed by years of irresponsible fiscal and monetary policy, the financial tide has certainly begun to go out in America. The ebbing tide has revealed serious shortcomings in the corporate management of a number of banks, including inadequate loan portfolio diversification and the imprudent accumulation of unhedged interest rate risk.

More significantly, the recent bank failures and the panicky government bailouts that followed have revealed the fundamental flaws that permeate the entire regulatory structure progressives have erected over the years to manage the operation of banks and every other aspect of the American economy.

The entire administrative state rests on a single profoundly mistaken organizing premise. It is the assumption, the unshakable belief, that credentialed experts with enough authority and resources can produce minutely detailed and finely calibrated systems of regulation capable of eliminating or at least mitigating any and every risk that might confront modern society, no matter the size or complexity of the threat.

This rigid mindset produced the draconian pandemic lockdowns, and it helps explain the overwrought predictions and ultimatums that regularly issue forth from the climate doomsday complex. In the area of finance, this mindset produced the Dodd-Frank Act as a response to the 2008 financial crisis that occurred when the housing asset bubble burst and the tide went out on the mortgage-backed securities that bundled high risk home loans.

The 2010 Dodd-Frank Act, over 800 pages long, directed dozens of regulatory agencies to revise or create new regulations covering every part of the financial system. The agencies responded by issuing hundreds of regulations containing more than 27,000 directives, prohibitions, and other requirements. Overall, Dodd-Frank produced one of the most extensive and complex expansions of regulation in American history.

The Dodd-Frank regulations and others imposed by the progressive administrative state have together become so numerous and complex and intertwined that compliance has become an all-consuming activity, and one that is dangerously routinized. With countless forms to fill out and reports to file, the endless box checking and paper pushing drains resources, distracts attention, and gives rise to a false sense of security that formal compliance with regulatory minutiae is equivalent to actual risk reduction.

This distracted complacency can produce disastrous results. Recall, for example, that the inadequate number of lifeboats carried by the Titanic was exactly the number of lifeboats required by British regulators. In the current case, the Dodd-Frank regime encouraged banks to invest their deposits in “risk-free” Treasury securities but failed to account for the negative impact that rising interest rates would inevitably have on the market value of such securities if they then had to be sold to fund deposit withdrawals.

Progressives promised that Dodd-Frank would protect consumers and investors, stabilize the financial industry, and end the need for taxpayer funded bailouts. In the face of Dodd-Frank’s failure to protect against even the most basic kind of financial risk, and its failure to eliminate bailouts, progressives are nevertheless calling for more of the same type of regulation to “strengthen” the oversight of financial markets.

Progressives are quick to ascribe every bad outcome to some sort of “market failure” that can be corrected by additional regulation of their devising. The term “market failure” obscures the vitally important fact that our problems, from bank runs to baby formula stock-outs, typically arise from regulatory failures. Market failures don’t exist in the absence of regulation; they are the result of regulation.

If we can realign our political debates and policy analyses to focus on the flaws and failures of the progressive model of regulation, we will be much better prepared when the tide goes out the next time.

J. Kennerly Davis, Jr.

Former Senior Attorney

Hunton Andrews Kurth LLP

Regulatory Process

Federalist Society’s Administrative Law & Regulation Practice Group

The Federalist Society and Regulatory Transparency Project take no position on particular legal or public policy matters. All expressions of opinion are those of the author(s). To join the debate, please email us at [email protected].

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