By HUNTER BLAIR
No, measure vital to protecting consumers should be expanded, not disarmed
Nine years after the financial crisis, the U.S. economy is only now approaching a full recovery. The economic waste and human suffering has been immense, and policymakers should work hard to ensure that nothing like this happens again. The financial crisis revealed regulatory failures across the board in the financial sector. Consumers were ill-protected from fraud. Unregulated over-the-counter derivatives were so complex that no one could see where the eventual risks would fall. What economists call moral hazard, and the rest of us call too big to fail, created incentives so that no one would look all too hard to find those risks, since public bailouts would be near-assured. A balkanized regulatory regime allowed the growth of essentially unregulated shadow banking. All of which culminated in a panic, set off by the collapse of housing prices. Bank runs, which we usually think of as being confined to reruns of “It’s A Wonderful Life,” reared their heads in 21st century style gripping the repurchase and money markets.
Besides the direct economic damage the financial crisis inflicted, the fact that much of policy response focused narrowly on restoring the financial sector (TARP and extraordinary actions undertaken by the Fed) soured many Americans on the efficacy of any public response to fight the recession (responses like the auto bailouts and the Recovery Act), even when these responses were extraordinarily valuable. All of this argues for having a policy infrastructure in place for the next crisis. When a financial crisis occurs, the necessary response is to figure out exactly why it happened, and add safeguards to ensure that it doesn’t happen again. Following the Great Depression, these safeguards were deposit insurance, the Glass-Steagall Act’s separation of commercial and (riskier) investment banking, and other banking regulations. Following the Great Recession, these safeguards were Dodd-Frank.
Dodd-Frank made significant improvements in each of the areas that led to the crisis. To be sure, there is more to be done. Financial regulation is never a one-and-done task. Banks will constantly probe for holes in the regulatory regime, and laws and rules and regulatory practices have to remain flexible and robust. In short, protecting and expanding Dodd-Frank is necessary to ensuring the stability of the banking system. Sadly, it appears the intention of the incoming Trump administration to do the exact opposite.
The good that Dodd-Frank has done so far is real and apparent. While consumer protection was ostensibly part of the mission of an alphabet soup of financial regulators before the crisis, none of these considered protecting consumers to be a priority. To rectify this, Dodd-Frank created the Consumer Financial Protection Bureau. So far, the CFPB has proved to be tough on banks that abuse or mislead customers — most notably fining Wells Fargo $100 million and requiring them to reimburse the customers that they defrauded by creating accounts that were never asked for and letting those accounts rack up fees.
Dodd-Frank has also shifted derivatives onto regulated public exchanges, and its fight back against too big to fail banks appears to be working. Dodd-Frank mandates that banks designated systemically important financial institutions be required to hold higher capital requirements and to submit “living wills” that provide a road-map to their own dismantling should they become insolvent. Capital requirements strengthen the equity cushion of banks to absorb losses, promote liquidity, and act to curb bank risk-taking by putting equity at risk. These living wills could have just been a rubber stamp, but to the credit of the current regulators, when the banks showed up with living wills that wouldn’t get the job done, regulators have forced them back to the drawing board time and again. Now only one bank, Wells Fargo, remains in violation of the rule and will be subject to escalating penalties and eventual divesting of assets should it continue to not address the regulators’ concerns.
Partisan politicians, who are opposed to anything the Obama administration is for, claim that Dodd-Frank institutionalizes bailouts. If this were so, one imagines banks would be clamoring to be labeled SIFIs, as such a designation would allegedly put them on the glide-path to taxpayer bailouts in the next crisis. Instead, banks have fought tooth and nail to escape the SIFI designation.
Useful extensions to Dodd-Frank are still needed. Even higher capital requirements can add more stability and further deter the use of public money to engage in private risk taking. The regulatory regime should be further extended to cover any companies that finance illiquid assets with liquid liabilities, whether they call themselves a “bank” or not. Finally, we should make an effort to reel in the excesses of the financial industry. Since the key rationales for a large financial sector are risk-management and macroeconomic stability, the financial crisis should’ve disabused us of the notion that the financial sector’s large size is economically efficient. The simplest way to do this is to place a small tax on financial transactions.
The acid test of Dodd-Frank’s success will only be known after the next potential crisis. People have short memories and powerful political actors in finance like the freedom to make large leveraged bets. Over time, this leads to regulatory protections that erode before the next crisis occurs. In keeping with this, the administration’s choice for Treasury secretary, former Goldman Sachs banker and foreclosure mill (OneWest) founder Steven Mnuchin has said that stripping back parts of Dodd-Frank will be a No. 1 priority on the regulatory side. His claim is that Dodd-Frank has impeded lending, helping to create the slow recovery. But big banks and the non-financial corporate sector are flush with cash that could finance potentially profitable investments. The National Federation of Independent Business has reported that only 2 percent of small businesses report financing as their top business problem. In short, lending is not constrained, and no provision of Dodd-Frank would lead to unnecessary restraints on lending. House Republicans have been fixated on disarming the CFPB, and installing regulators intent on dismantling Dodd-Frank, and now they have a president sympathetic to their cause. If we let them, our short memories and the political power of finance will have set the stage for the next crisis.
Hunter Blair is a budget analyst for the Economic Policy Institute.