Protect Your Wealth Against the Law of Unintended Consequences

Friendship. Liberty. Hope.

These are among the cruelly ironic names given to ships involved in the transatlantic slave trade, if you can believe it. Giving the vessels agreeable names helped obscure the terrible truth of slavery and no doubt eased the consciences of captains and crewmembers alike.

Today, lawmakers often follow the same tactic when they give cute names to legislation that was well-intentioned but had unintended consequences.

Think of the “Patient Protection and Affordable Care Act.” Or the “U.S.A. PATRIOT Act.”

The word “patriot” carries such strong connotations for Americans. Who would deny being a patriot?

And yet the PATRIOT Act, signed into law following the September 11 terrorist attacks, has a decidedly rocky past. Intended to strengthen national security, it’s been criticized for having a number of negative repercussions, including serious privacy violations, guilt by association and much more.

“A rose by any other name would smell as sweet,” Shakespeare writes. Conversely, a law with a great name doesn’t hide that it may not have been carefully considered.

The law may perhaps be even more suspect when it’s given a boring, almost clinical name. The Department of Labor’s (DOL) “Fiduciary Rule” and the “Recourse Rule” both come to mind.

The Law of Unintended Consequences

I called the Fiduciary Rule one of the costliest financial regulations of the past 20 years. Meant to protect investors from nosebleed fees and advisors’ conflicts of interest, the rule may end up costing investors in the long run. A “cheaper is always better” attitude will surely exclude many smaller funds, ultimately giving retail investors fewer choices. Although the rule died in court last year, the DOL is expected to unveil a new version by the end of the year.

And then there’s the Recourse Rule. The little-known rule, enacted in 2001, is now widely believed to be partly responsible for the financial crisis that began in August 2007. I won’t get into the full details of what the rule did. In short, it changed banks’ capital requirements. Holding individual mortgages was given a greater risk-weight than highly-rated mortgage-backed securities (MBS), and so banks, trying to sidestep the additional capital requirements, securitized the loans—many of them “non-prime”—to which rating agencies gave the coveted AA- or AAA rating.

Those who’ve read Michael Lewis’ fabulous account of the housing bubble, The Big Short, or seen the Academy Award-winning film of the same name, know how this turned out for lenders—and, consequently, the world economy.

Over-regulation, then—as opposed to under-regulation—may have been the root cause of the worst economic crisis since the Great Depression.