I find myself very amused by this point being made by Craig Pirrong. Not amused as in I'm laughing because I think he's wrong. Rather, amused in the sense that the people constructing these new apparatti to regulate the financial markets don't seem to understand that they're making the very problem they're trying to regulate against worse.
Craig's point is simple:
Frankendodd creates a huge regulatory overhead that in turn leads to scale economies. Smaller-to-medium-sized entities will not be able to afford these overhead costs, and will exit the business, and the bigger firms will get bigger. The overall level of activity is likely to go down as a result of the exit and expansion, but the biggest firms are likely to get bigger even if the market overall gets smaller.
Regulation always imposes a cost on those being regulated. Even if the regulation is entirely necessary, is totally just and righteous, there's still a cost to the companies or people having to obey the regulations. Partly it's in what they can or cannot do. But a lot of it is just the sheer time and effort that has to go into proving that you are in fact obeying the regulations.
That cost can be significant too: don't forget that vast fine just handed out to HSBC over money laundering. No, they were not found guilty of money laundering. No, it has not been proven that they were moving drug money. What has been proven is that their paperwork was not good enough for HSBC to be able to prove that they were not drug money laundering. Their actual crime was not following the paperwork regulations about money transfers, not money laundering itself.
Small firms cannot afford these increased regulation costs: thus they will move out of markets where there is heavy regulation. Obviously, this means that the market becomes ever more dominated by the large firms that can absorb the overheads of the regulation.
Which leads us to the conclusion about the various attempts around the world to solve the "too big to fail" problem. This is being done largely by regulation: but regulation in itself concentrates business among those large institutions. Precisely where we don't want it to be for the more concentrated the market is then the more problems we have with too big to fail.
And the horrible thing about this is that there is no solution. We cannot solve too big to fail through regulation for regulation increases the problem of too big to fail.
