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“Too Big to Fail” – Regulatory and Technology

August 9, 2015
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Clearly since the financial crisis of 2008 the U.S. Government, the Federal Reserve, social activists and pundits have been preoccupied with the idea of “Too Big to Fail”. The U.S. government enacted the Dodd–Frank Wall Street Reform and Consumer Protection Act on July 10, 2010. As described by President Obama, this Act to change the U.S. financial regulatory system (and impact the global financial system) would be a “sweeping overhaul of the United States financial regulatory system, a transformation on a scale not seen since the reforms that followed the Great Depression”.

The greatest impact of Dodd-Frank on the marketplace has been the destruction/elimination of entrepreneurial. Instead of controlling those financial entities that are “too big to fail”, Dodd-Frank has enhanced their size, power and market competitiveness as compared to smaller entities. The regulatory framework which Dodd-Frank has put in place has all but limited entrepreneurial development of financial institutions, such as start up hedge funds or new start-up banking/financial institutions, The Dodd-Frank Act has not only increased the likelihood that a large entity will need to be protected from failing, but also that its failure will have a significant and systemic impact as these entities have become even more pervasive throughout American society and the economy.

A University of Pennsylvania law professor, David Skeel has concluded the law has two major themes which are “government partnership with the largest Wall Street banks and financial institutions”, it is “a system of ad hoc interventions by regulators that are divorced from basic rule-of-law constraints” and “the overall pattern of the legislation is disturbing” [Source: The New Financial Deal: Understanding the Dodd-Frank Act and its (Unintended) Consequences].

These conclusions are supported by “Monopolist Theory” which holds that the concentration of business activity, while easier to regulate, has a higher cost on society. If the U.S. Government or even social activists really wanted to reduce the impact of “too big to fail” they would have been better off de-consolidating these business entities. This is because the cost of regulation is such a barrier-to-entry, that the only beneficiaries of the legislation are those entities that are the largest.

[Aside: The larger the entity the more likely it is willing to give to political parties and politicians that will promote/protect their interests from competition, entrepreneurialism and start-up technologies].

In 2003, given today’s standards, one could start a hedge fund with an inconsequential amount of money and own the management company. One could also attract investors and service providers, such as a major prime broker, a top-tier administrator, and other firms, to support a firm’s development. Today, the notion of initiating a fund of any type, particularly in an entrepreneurial manner, by raising anything less than $50 million to $100 million is a pipe dream. And, to accomplish such a capital raise and still control your own destiny, well suffice it say it might only be accomplished if such a fund was focused on the marijuana industry (e.g. since today you have to be federally regulated by the U.S. Securities & Exchange Commission and marijuana is still illegal on a federal basis, it is likely you will be going to jail very quickly).

However, what prompted this discussion of regulatory and “too big to fail” was not by a desire to initiate a new fund (however, if parties would provide the capital for such an endeavor in the agricultural or shipping/transportation/commodity industries it would be considered), was a trucking and agriculture technology conference sponsored by Piper Jaffray on August 4th/5th in Minneapolis. The regulatory pervasiveness of the U.S. government hit home during this conference.

Regulatory impacts in every industry are causing significant dislocations for the entrepreneur. On top of regulatory requirements, the need to embrace technology to comply with regulatory requirements is wiping out the small rig owner in the trucking business, the small farmer and making it impractical for anyone in most industries to consider a start-up operation. It was amazing the amount of technology that is required to operate a truck rig or the burden that is being imposed by the U.S. government and its agencies on the small American farmer. For a person who has been involved in the shipping industry, that naive feeling was present until one thinks back to the enactment of the Oil Pollution Act of 1990 (“OPA”) and subsequent regulatory legislation.

However, it became more glaringly obvious that the historic engine of American growth, the entrepreneur, is being wiped off the map. The entrepreneur is becoming the exception, rather than historical natural party that pulled the economy out of a recession. The U.S. government and the supporters of regulation are eliminating the risk taker who creates new businesses and technologies. It is not just eliminating the desire of entrepreneurs and the development of start-ups; given today’s regulatory environment, start-ups are also less likely to be able to acquire financing from banking institutions and service providers, as these entities are controlled by larger institutions that have greater lending and reporting restrictions on them by government (increased regulatory).

Regulatory requirements and the technology necessary to support its burden have been increasing rapidly for every industry. If one doesn’t think that regulatory requirements and need to specifically support this effort with every increasing amounts of technology is not impacting their business growth and profitability, they are mistaken. Technology is important and one should not argue against it; however, the cost of technology specifically focused on supporting regulatory is such a burden, that only larger entities can survive current and prospective requirements.

So, why has growth and the recovery of the U.S. and the global economy been such a painstakingly slow process since 2008? One can not understate that deflationary pressures being experienced in the U.S. and global economy will remain for some time due to regulatory (and the technology requirements necessary to support the regulatory) and a lack of entrepreneurialism. And, it is unlikely to think that investors should expect that our economy will see a substantial expansion of growth given the regulatory environment in the U.S. and globally. 

We need to thank our politicians and government being “intellectual neanderthals” when it comes to managing the U.S. economy (however, they are working in their own financial interest). And, for all those small firms, figure a way to get larger quickly because more regulation is around the corner….

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