Job-Killing Financial Reform

While we here on Main Street are hoping to survive the Great Recession, politicians in Washington are gearing up to make matters worse with Democrat Senator Christopher Dodd’s 1,400-page financial market takeover.

Until some late tinkering, this bill, passed by the U.S. Senate and in reconciliation as of this writing, would have negatively impacted the ability of entrepreneurs to raise angel capital in Wisconsin and to grow their young businesses and create jobs. That provision was wisely removed from the measure before passage, but the fact it was there in the first place does not say much about the economic literacy of the people who are governing us.

The bill was set to impose significant new regulations on entrepreneurs who try to raise angel capital, despite the fact they did not contribute to the financial market meltdown. For example, the original bill would have increased the threshold of angel investor income and net worth by 80% and 130% respectively, to levels almost impossible for many angel investors to qualify. Likewise, the original version imposed a 120-day review period with the SEC, something not required now and likely to take much longer in practice.

Investments by angels (usually $100,000 or less) helped launch, started by one young entrepreneur and now the City of New Berlin’s fifth largest taxpayer, employing 2,600 people in a new 300,000-square-foot manufacturing and distribution facility.

Angel investments also launched FlameDisk, a new, ethanol-based barbeque "plate" that will replace charcoal briquettes for backyard cooking. SoloGear, the company that manufactures FlameDisk, now employs roughly 100 people in its Middleton manufacturing facility.

In Wisconsin alone, I am aware of more than 120 start ups that need angel capital. The Democrats’ Senate bill almost prevented those entrepreneurs from securing the capital they need to grow and create new jobs. Even worse, existing entrepreneurs that need a second round of capital would have found it impossible to secure it on a timely basis.

According to the Wall Street Journal, $19 billion was invested in 55,000 start ups in 2008 alone. Those young businesses are the global companies of tomorrow. Apple Computer, Google, Amazon, and many others are examples of start ups that began with angel capital and grew into major job creators.

Angel investing, now regulated by state governments, would have had another layer of regulation by the federal government. The feds have a horrible record of policing the financial markets, but they apparently want to police every small financial services firm across the country. Shouldn’t they get their own house in order first?

They did not shut down Madoff despite being warned; they did not shut down Stanford even after the regulators came to their own conclusion that his business was a Ponzi scheme; and there are many more cases of federal regulators failing to do their job. But now they want to take on even more. What happened to states’ rights? What happened to the Tenth Amendment?

The removal of the offending regulations on start-up investors does not mean other questionable provisions were removed prior to passage. The Democrats’ bill would still create a massive new federal agency, the Consumer Financial Protection Bureau, which sounds nice but will add tens of thousands of new government jobs and cost tens of billions of tax dollars. Worse still, the Bureau will be housed in the Federal Reserve Bank! That’s right, the very bank that contributed to the crisis by keeping the money supply too loose, which inflated the bubble, is rewarded with more power. The Fed messes up and Dodd rewards them with more oversight.

While Dodd and company were trying to control Main Street, they exempted the real culprits. Warren Buffet reportedly talked Dodd out of including a provision in the bill requiring that companies speculating in derivatives maintain prudent cash reserves to cover a portion of their liabilities. Currently, BuffetÕs Berkshire Hathaway maintains zero reserves on over $63 billion in derivatives. Talk about risk!

Insurers that provide insurance contracts are required to maintain cash reserves to cover potential claims from policy holders. Companies like Berkshire that in effect provide derivative "insurance" should likewise have to maintain reserves. Otherwise, it’s just another Ponzi scheme in which claims would be paid out of current contract premiums. This kind of behavior is how Merrill Lynch, our nation’s largest banks, and AIG got into trouble, thereby contributing to the financial collapse.

To top it all off, Dodd’s bill granted the new bureau the authority to write its own rules. In other words, the bill hands over to a regulatory agency the authority to write new law, any law, without further Congressional approval. That’s a direct violation of the Constitution, which says that only Congress has the power to write law.

I’m in favor of appropriate regulation of the unregulated derivatives industry and separating the traditional banks from the investment banks (the Volcker Rule), given that investment banks like to gamble in the commodities and derivatives markets with depositors’ money. But this bill doesn’t do that. What it does do is over-regulate every small business across America that offers any kind of financial product or service.

Ironically, in the case of angel investing, there is nothing broken. The angel investor rules are working to protect angel investors from themselves! Current regulations make securing capital from angel investors difficult. If anything, if we want the U.S. to incubate and grow young start-up technology businesses that will become the major employers of tomorrow, we need to loosen up the regulations impacting small businesses on Main Street. Washington actually was going to move in the other direction, making the funding of future Googles nearly impossible.

That’s typical of Washington. Their idea of fixing a problem is to reward those who caused the problem, and then write a bill to regulate those on Main Street who had nothing to do with it, and then declare it "fixed." This bill will do nothing to prevent another similar financial crisis, and we wonder why the politicians in Washington have bankrupted our nation!

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