Dismantling Dodd-Frank May Have to Wait

Republicans’ big idea to keep banks safe is too loose for Democrats and too strict for banks.
Photo illustration by 731; Photographer: John Lund/Blend Images/Getty Images

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 looked like a goner when President Donald Trump was elected in November. During the campaign, Trump repeatedly blasted the law as a loan-killing, anti-job disaster. His party is filled with lawmakers who are even more opposed to it than he is. “On behalf of all hardworking, struggling Americans, I will not rest, and the House Financial Services Committee will not rest” until Dodd-Frank is repealed, committee Chairman Jeb Hensarling of Texas vowed last May.

Now, though, the drive to wipe out or scale back Dodd-Frank has lost momentum. Trump issued an executive order on Feb. 3 for Treasury Secretary Steven Mnuchin to review the law, but the president made no mention of it in his priority-setting speech to Congress on Feb. 28. As with the Republican vow to repeal Obamacare, the sticking point may be finding a replacement for the law on the books.

“We need to regulate more simply, cut back on unintended consequences, and see if we can recalibrate this,” says Douglas Elliott, a partner at management consulting firm Oliver Wyman. “That happens to be an extremely hard thing to do.”

Hensarling does already have a bill in the House, the Financial Choice Act, that’s being given long odds. “We think the chances that the bill becomes law are less than 20 percent—maybe as low as 10 percent,” Brian Gardner, Washington analyst at the investment bank Keefe, Bruyette & Woods, wrote to clients on Feb. 16. Even so, the bill offers a glimpse into Republicans’ thinking on how to shape financial regulation.

The Democrats who pushed through Dodd-Frank sought to regulate multiple points in the financial system, because there are lots of places it can fail, from mortgage underwriting to derivatives trading. Republicans prefer to harness market forces to keep companies in line. Where there must be rules, they like them to be simple and broad.

The Hensarling bill’s main innovation is to give banks an offramp from some of Dodd-Frank’s regulations. But to use it, a bank would have to maintain a leverage ratio of 10 percent or more. That’s a measure of capital, or how much a bank’s assets are worth compared with its liabilities, which include customers’ deposits and debt owed to bondholders. Roughly, a ratio of 10 percent means that for every $100 of a bank’s assets, it owes only $90. This gives the bank a safety cushion if assets decline in value, much like having equity in a home. Today only some small banks have a cushion that thick. Banks argue that higher capital standards force them to make fewer loans, but their lending as a share of gross domestic product has rebounded—although not to its 2006-07 bubble high—even with a big increase in capital.

Hensarling makes the case that the market can provide discipline: Shareholders have a strong incentive to make sure their bank behaves responsibly, because they’re the first to get wiped out if it fails. When a bank is liquidated, the assets are sold for whatever the market will bear. Shareholders get zero unless there’s money left after paying off depositors, lenders, and other creditors.

Bank lending fell sharply after the financial crisis.

Unfortunately for Hensarling, his bill is being attacked from all sides. Bankers say the leverage ratio he advocates is unreasonably high. “The U.S. banking system does not need even more capital,” Jeremy Newell, general counsel of the Clearing House Association, a trade group of the largest commercial banks, testified to Hensarling’s committee in July.

Congressional Democrats, meanwhile, are wary of relying too much on just the safety cushion. Dodd-Frank mandates especially close supervision of the big banks whose failure would be the most destructive. Dismantling those layers of safeguards would risk a repeat of the financial crisis, argues Maxine Waters of California, the top Democrat on Hensarling’s committee. The Senate, where 60 votes would be required to stop a Democratic filibuster, is the biggest obstacle.

Even advocates of higher capital standards aren’t fully behind Hensarling’s bill. Anat Admati, a Stanford finance professor who’s argued that banks need far bigger cushions, says she agrees with Hensarling that some regulations should be rolled back but worries that banks might find ways around leverage ratios by playing accounting games. “If you’re going to put all your eggs in one 10 percent magic number, that number had better be meaningful,” she says.

With Obamacare, taxes, and the budget consuming all the oxygen in Washington, Congress may not get around to Dodd-Frank until 2018 or beyond. Even then the changes could be limited, such as regulatory relief for smaller banks that don’t pose systemic risks, says KBW’s Gardner. Lately, the big banks are putting their lobbying energy into something more subtle: getting the Federal Reserve to ease up on its comprehensive capital analysis and review of big banks, a process known as CCAR.

“CCAR rules have been ratcheted unreasonably and progressively tighter,” Greg Baer, president of the Clearing House Association, wrote in an e-mail. A more industry-friendly CCAR process at the Fed could effectively allow banks to pay out bigger dividends and maintain less capital, amping up their potential return on equity but also their risk. Trump has some influence over that process, because he can fill three seats on the seven-member Board of Governors of the Federal Reserve System. When it comes to bank regulation, it’s not only the laws you write that matter, but the zeal of the watchdogs.

The bottom line: Dismantling Dodd-Frank may have to wait. In the meantime, Trump can influence who’s in charge of regulation.

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