Some initial thoughts on banking reform
By Scott Sumner
There’s a new Congressional proposal for banking reform:
NEW YORK – House Financial Services Committee Chairman Jeb Hensarling (R-TX) today unveiled details of the Financial CHOICE Act – the Republican plan to replace the Dodd-Frank Act and promote economic growth. CHOICE stands for Creating Hope and Opportunity for Investors, Consumers and Entrepreneurs. . . .
The Financial CHOICE Act, which Chairman Hensarling said will be introduced as legislation later this month, will end taxpayer-funded bailouts of large financial institutions; relieve banks that elect to be strongly capitalized from “growth-strangling regulation” that slows the economy and harms consumers; and impose tougher penalties on those who commit fraud as well as greater accountability on Washington regulators. . . .
BANKRUPTCY, NOT BAILOUTS
To end taxpayer-funded bailouts and “too big to fail,” the Financial CHOICE Act will create a new subchapter of the Bankruptcy Code tailored to specifically address the failure of large, complex institutions. In April, the House approved similar bipartisan legislation to establish a new bankruptcy process for financial institutions with assets of $50 billion or more.
“Taxpayer bailouts of financial institutions must end, and no company can remain ‘too big to fail,'” said Chairman Hensarling. As a result of the Republican plan, “some large firms will likely become smaller because the credit they now obtain will be priced according to their inherent risk of failure without implicit government guarantees backing firms that are ‘too big to fail.’ As a result, failure — when it does happen — will be more contained.”
STRONGLY CAPITALIZED BANKS
Banks that make the choice to be strongly capitalized will be eligible for relief from Washington regulations “that create more burden than benefit,” Chairman Hensarling said. “To avail themselves of this exchange, many larger banks will have to raise significant additional equity capital. Most community banks will have to raise little to no additional capital. Regardless, the option remains with the bank.”
PRO-GROWTH REGULATORY RELIEF
The Financial CHOICE Act also includes more than two dozen measures to provide additional regulatory relief for community banks and credit unions. While big banks have gotten even bigger since Dodd-Frank became law nearly six years ago, community financial institutions are disappearing at an average rate of one per day. Dozens of witnesses representing small banks and credit unions have come before the Financial Services Committee to describe the harm caused to their customers by the avalanche of Washington’s post-crisis regulations.
1. How can we be sure that this proposal will eliminate “too big to fail”? Here is some added information from the Executive Summary:
*Retroactively repeal the authority of the Financial Stability Oversight Council (FSOC) to designate firms as systematically important financial institutions (SIFIs).
*Repeal Title II of Dodd-Frank and replace it with a new chapter of the Bankruptcy code designed to accommodate the failure of a large, complex financial institution.
*Repeal Title VIII of the Dodd-Frank Act, which gives the FSOC authority to designate certain payments and clearing organizations as systemically important “financial market utilities” (FMUs) with access to the Federal Reserve discount window, and retroactively repeal all previous FMU designations.
*Restrict the Fed’s discount window lending to Bagehot’s dictum.
*Prohibit use of the Exchange Stabilization Fund to bailout financial firms or creditors.
*Repeal Dodd-Frank’s so-called “Hotel California” provision.
Does that actually prevent the Treasury from bailing out large banks?
2. In my view, the biggest problem with our banking system is moral hazard. The bill does address TBTF, but doesn’t seem to address the GSEs, and it does not seem to reform deposit insurance. In my view those are bigger problems than TBTF. I worry that special interest politics may have prevented meaningful reform in those areas.
3. On the plus side, it would seem that higher capital requirements are a superior option to the Dodd-Frank approach, which involves lots of burdensome regulation, moving in the direction of treating banks like regulated utilities. As Hensarling pointed out in his speech, the problem was not too little regulation, it’s that the government is not good at regulating banks.
Dodd-Frank’s false premise is that an alchemy of Wall Street greed, outsized private risk and massive Washington de-regulation almost blew up the world economy. According to their narrative, this necessitated massive taxpayer bailouts and a functional occupation of our capital markets by federal regulators.
But financial regulation did not decrease in the decade leading up to the crisis – it markedly increased. In fact, regulatory restrictions on financial services grew every year between 1999 and 2008. Financial services was, and remains, one of the heaviest regulated industries in the economy.
It wasn’t de-regulation that caused the financial crisis; it was dumb regulation.
The point of higher capital requirements is to offset the bias towards risk taking produced by distortionary policies such as FDIC and the GSEs. So that part of the reform seems sensible. What are the arguments in favor of Dodd-Frank?
4. I also like the pushback against CFPB regulations restricting things like payday loans.
Repeal authority to ban bank products or services it deems “abusive” and its authority to prohibit arbitration.
CFPB regulations could push lower income borrowers toward loan sharks.
5. I also like the idea of making the Fed more accountable:
Demand greater accountability and transparency from the Federal Reserve, both in its conduct of monetary policy and its prudential regulatory activity, by including the Housepassed FORM Act.
But the devil is in the details.
Overall this seems a step in the right direction, but I’d need to know much more about the details to have a firm view of this proposal. I’m a bit concerned about all of the rhetoric in favor of small banks, as I see them as a bigger risk than large banks. But perhaps that is just politics; you need to sound pro-small bank to get anything passed in Washington. And again, I’d like to see abolition of the GSEs and reform of FDIC, but I understand that the power of the banking/real estate lobby makes that very difficult.
I would appreciate comments from people who know more about this bill than I do, both for and against.
HT: Chad Reese