For those of you who do not know what the Dodd-Frank Bill is (I suspect the number is small), I will spend a moment enlightening you. The formal name of the legislation is the Dodd–Frank Wall Street Reform and Consumer Protection Act. It was signed into federal law by President Barack Obama on July 21, 2010. Passed as a response to the Great Recession, it brought the most significant changes to financial regulation in the United States since the regulatory reform that followed the Great Depression. It made changes in the American financial regulatory environment that affect all federal financial regulatory agencies and almost every part of the nation’s financial services industry. Yippee! The bill passed along party lines. Guess which party was “for it?”
Dodd-Frank has been the law of the land for more than 6 years now. So are we now safe from the next financial crisis? Financial crises like the Great Recession are very uncommon. The last meltdown that was of similar magnitude was in the early 1980s. Some would say we would need to go all the way back to the Great Depression of the 1930s for something of this magnitude. Thus, we would need to wait some 25 – 80 years to find the answer to the question of whether or not Dodd-Frank will protect us from the next major financial crisis.
The more appropriate question is whether or not Dodd-Frank better prepares us to handle the next financial debacle. Sadly, I must inform you that the answer to that question is “no.” Indeed, the opposite may be the case. President Trump is itching for a fight with Democrats over reining in the Consumer Financial Protection Bureau, one of the most contentious reforms in response to the 2008 financial meltdown. Just two weeks into his presidency, he took aim at the bureau with an executive order to begin unraveling the rules and regulations. Hopefully the Dodd-Frank Act “id toast,” as the saying goes.
[Source: Dodd-Frank’s Achilles heel, by Robert J. Samuelson]
To see why, you need to understand Section 13(3) of the Federal Reserve Act and its role in the last crisis. It’s the sleeper issue in judging Dodd-Frank.
By their nature, financial crises are unexpected, fast-moving and chaotic. Government’s goal is to defeat panic: the terror-driven rush to sell stocks and bonds or withdraw funds from financial institutions and markets. Panic becomes self-fulfilling. Less wealth and more fear depress spending and raise unemployment. In 2008-2009, the Fed — aided by the Treasury and the Federal Deposit Insurance Corp. — arrested panic by lending huge amounts to besieged markets and institutions. At its peak, the Fed’s loans totaled about $1.5 trillion.
Much of this lending couldn’t have occurred without Section 13(3). Normally, the Fed lends only to deposit-taking commercial banks. In the crisis, it also lent to or supported money-market funds, commercial paper markets, investment banks and a major insurance company (AIG). It could do so because Section 13(3), enacted in 1932, said that “in unusual and exigent circumstances” the Fed could lend to almost anyone — individuals, industrial companies, non-bank financial institutions.
Section 13(3) enabled the Fed to serve as a true “lender of last resort.” Many economists believe that this may have prevented a second Great Depression. And how did Congress, via Dodd-Frank, reward the Fed’s good deeds? It handcuffed (maybe gutted) 13(3).
Dodd-Frank’s restrictions on 13(3) loans include: (1) the treasury secretary must approve any lending; (2) loans can’t be focused on an individual firm (example: a wobbly money-market fund) but must be open to a broad class of borrowers; (3) the names of borrowers must be disclosed to Congress within a week; and (4) there are stricter standards for loan collateral. “I’m concerned that the restrictions . . . limit more than is wise,” Donald Kohn the Fed’s vice-chairman during the crisis, said at a recent Brookings Institution conference. Other commentators agreed.
While I am not a big fan of the Federal Reserve, one must admit that they stepped up to the plate during the financial collapse. Indeed, the Fed loans to banks have been repaid with interest ($19 billion profit). However, the loans to Fannie ($91 billion), Freddie ($51 billion), AIG ($23 billion), and GM ($27 billion) are much muddier to sort out repayment. The charge that the Federal Reserve fostered “too big too fail” is only partially accurate. Indeed, they did prop up Citigroup and AIG, but many failed or were forced to sell out at low share prices: Lehman Brothers, Bear Stearns, Merrill Lynch, Wachovia, Washington Mutual.
One thing is for sure, bankers do not like Dodd-Frank (see quotes in footnote). Overall, I’ll take the Federal Reserve over Dodd-Frank (and, my friends, that ain’t sayin’ much).
Quotes From Traditional Banks About Dodd Frank
“The regulatory costs are overwhelming in our industry right now…Virtually everyone in our bank now is involved to some extent or another in complying with regulations, and so it has taken away from their ability and their resources to work with both existing customers and also to go out and solicit new customers, helping other people get businesses off the ground.” — John A. Klebba, President and Chief Executive Officer, Legends Bank
“And I charge you with this, 40 years ago I did not see problems in banks and banks falling like flies, and yet the level of regulation and the cost of regulation was far, far less than it is today. As I see it from my standpoint, we will see community banks continue to decline. We simply cannot afford the high costs of federal regulation. And as one banker I will tell you this, my major risks are not credit risks, risks of theft, risks of some robber coming in with a gun in my office; my number one risk is federal regulatory risk. And I have a greater risk of harm to my bank, my stockholders from the federal government than I have anything else in this whole world. That is obscene.” — Les Parker, Chairman, President and Chief Executive Officer, United Bank of El Paso de Norte
“Over the last several years, banks have faced increased regulatory costs and will face hundreds of new regulations with the Dodd-Frank Act. These pressures are slowly but surely strangling the traditional community banks, and handicapping their ability to meet the credit needs of their communities.” — Matthew H. Williams, Chairman and President, Gothenburg State Bank
“There’s no question that the current regulatory and examination environment is an impediment to the flow of credit that will create jobs and advance the economic recovery.” — Mr. Marty Reinhart, President, Heritage Bank
“As one who has worked in community banks for over four decades, I maintain that despite policymakers’ good intentions in implementing regulations, they are ultimately detrimental to banks’ ability to grow and create capital in other communities and to build communities through job creation. Without community banking, we will no longer be the America that created the largest economy in the world. We have already lost over 11,000 community banks since 1985; we cannot afford to lose anymore.” — Ignacio Urrabazo, Jr., President, Commerce Bank
“And I totally support the idea that there should be smart–you have to have regulation. But we are regulating community banks particularly down to the point where there is barely room to breathe. That is not how you get the economy going. And that is not how you lend money out.” — Tim Zimmerman, President and Chief Executive Officer, Standard Bank
“The amount, intensity and uncertainty of new Federal regulations, chiefly the Dodd-Frank Act, have forced banks to allocate an enormous amount of time and resources to compliance, and away from our primary mission of serving our customers.” — Todd Nagel, President, River Valley Bank
“To community banks like mine, regulation is a disproportionate expense, burden, and a real opportunity cost. My compliance staff is half as large as my lending staff. This is out of proportion to our primary business: lending in our communities to support the local economy.” — Salvatore Marranca, President and Chief Executive Officer, Cattaraugus County Bank
“The bigger banks can absorb it, the smaller banks can’t. I would not be surprised to see half of the community banks in this country go out of business if we don’t give some relief from Dodd-Frank for them. I think that Dodd-Frank is a terrible piece of financial legislation. It didn’t address any of the causes of the crisis that we just went through. It won’t prevent the next crisis. It’s heaped volumes and volumes of regulations. What they’re missing here is that when you require banks to capitalize for a depression, it’s going to be awfully hard to get this economy moving. Loan growth has almost been non-existent for the past three years. It’s hurting the people who need the money the most. It’s hurting small business. I think it is impeding economic growth.” — Bill Isaac, Former FDIC Chairman and Chairman of Fifth Third Bancorp
“Community banks have been the life blood of this country, and they’re responsible for more small business successes than any other resources including government programs. What’s troubling to me and to my bank is the impact of government regulation that has been based not upon common sense but on politics.” — George Hansard, President, Pecos County State Bank
“If Dodd-Frank is allowed to stand and proliferate as a monster regulatory overhaul, only the largest institutions will be able to navigate its requirements, and the community institution model will continue to diminish. The cost of regulatory compliance is simply staggering. I’m not talking about efforts to keep an institution out of trouble; I’m talking about a well-meaning community institution that has no intention of being unfair to members of their own town. These smaller institutions spend a disproportionate amount of money and time to just meet the reporting and manpower requirements of this new regulatory overkill.” — Cliff McCauley, Executive Vice President, Correspondent Banking, Frost Bank
“Most banks in the Midwest did not participate in the underwriting practices that contributed to the recent recession. Sadly, however, we are paying for the past through costly new regulatory burdens, anxious examiners, and customers that are unwilling to borrow. These remedies are hitting all hearts of our financial statements, as costs are going up, opportunities to earn revenue have been curtailed, and the amount and cost of capital we need is increasing.” — G. Courtney Haning, Chairman, President and Chief Executive Officer, Peoples National Bank
“We know that there will always be regulations that control our business–but the reaction to the financial crisis has layered on regulation after regulation that does nothing to improve safety or soundness and only raises the cost of providing credit to our customers. As a banker, I feel like Mickey Mouse as the Sorcerer’s Apprentice in Disney’s famous cartoon Fantasia. Just like Mickey with bucket after bucket of water drowning him, new rules, regulations, guidances, and requirements flood in to my bank page after page, ream after ream. With Dodd-Frank alone, there are 3,894 pages of proposed regulations and 3,633 pages of final regulations (as of April 13) and we’re only a quarter of the way through the 400-plus rules that must be promulgated. While community banks pride themselves on being flexible and meeting any challenge, there is a tipping point beyond which community banks will find it impossible to compete.” — William Grant, Chairman, President and Chief Executive Officer, First United Bank & Trust
“But the role of community banks in advancing and sustaining the recovery is jeopardized by the increasing expense and distraction of regulation drastically out of proportion to any risk posed by community banks. We didn’t cause the recent financial crisis, and we should not bear the weight of new, overreaching regulation intended to address it.” — Samuel Vallandingham, Vice President and Chief Information Officer, First State Bank
“Once again, community banks will suffer for the problems created by big banks and investment houses. Dodd-Frank, while attempting to “fix” the financial services industry, has come up short in correcting the problems that created today’s economic uncertainty. Thousands of pages of new compliance requirements stemming from this legislation and from the Consumer Protection Act will continue to burden many financial institutions dedicated to serving local communities and supporting Main Street businesses.” “Some community banks will find it financially impossible to operate independently and competitively while complying with the host of expected regulations, and that will lead to consolidation among smaller banks. And that will mean hardships for many small businesses that depend on their neighborhood bank. Many of our small business customers tell us that they left large banking institutions because of their inability to obtain credit and the high service fees charged by these banks. Few deals were sealed with a handshake — one of the hallmarks of community banking.” — Douglas C. Manditch, Chairman and CEO, Empire National Bank