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Dodd-Frank, 4 Years In, Is Vague, Complex, and Still Fighting the Last War

NEW YORK (TheStreet) -- On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act became law. And at the beginning of its fifth year, Dodd-Frank's complete package still hasn't been revealed. Nor have we fully experienced the impact it is going to have on the American economy.

The law is vague and complex at the same time.

It can be argued that good laws deal with process and not outcomes. The resulting Dodd-Frank legislation seems to be more about what legislatures want the banking industry to be rather than how it would like to see the banks function.

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Congress probably wants financial institutions that have minimal risk, are consumer friendly, and are generous lenders to families wanting to own their own home and to small- and medium-sized businesses that provide lots of jobs to Main Street.

The result -- Dodd-Frank's 2,300 pages and 398 regulations -- can only be seen as overkill. Congress is trying to mold the banking system. But in my view this kind of legislation does not work.

Look at the environment the banking system has faced over the past 50 years and what it faces going forward. Since the early 1960s, the economic climate in the U.S. has been one of credit inflation. Credit inflation hits not only the prices of the goods and services that are produced and consumed within a relatively short span of time, it also includes the prices of assets like houses, commodities and stocks and bonds.

Since the early sixties, the government of the U.S., whether controlled by Republicans or Democrats, has generally pushed on the credit accelerator. The goal was to keep employment at high levels and to achieve other plans, like increasing home ownership.

This environment produced incentives that resulted in financial institutions making riskier loans, increasing their financial leverage, mismatching the maturities of assets and liabilities, and creating increasingly complex financial innovations. And all of these consequences of credit inflation made the banking system more vulnerable to shocks.

But credit inflation is still the name of the game. And the incentives that go with credit inflation will return.

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