The Man Who Would Kill Dodd-Frank
Representative Jeb Hensarling, a Texas Republican who wants to overhaul financial regulation, is under consideration to be Donald Trump's Treasury secretary. Even if the job goes to someone else (hedge-fund manager Steve Mnuchin appears to be the front-runner), Hensarling's chairmanship of the House Financial Services Committee will give him vast influence over Wall Street next year.
He and Trump believe the 2010 Dodd-Frank Act has kept banks from lending and the economy from growing, and they want to repeal and replace it, to borrow a favorite Republican phrase. But the congressman's replacement bill, which has several good deregulatory ideas, would go too far by reversing changes that have made the banking system safer.
Dodd-Frank, one of President Barack Obama's signature achievements, was supposed to make sure that a financial crisis like the one in 2008 never happens again. But even staunch supporters of the law concede that some of Hensarling's deregulatory ideas make sense.
The 2008 crisis was caused mostly by bank regulators' failure to see dangerous risks building in the mortgage-finance business. Among other things, Hensarling would relieve smaller banks of many of the law's arcane rules, which were meant to rein in the biggest, riskiest money-center institutions, not tiny community banks.
He would also lighten supervision of large banks whose ratio of capital to assets is at least 10 percent. While the ratio probably should be higher -- at least 15 percent and preferably 20 -- Hensarling has the right idea: The best way to guard against a system-wide crash is by requiring banks to have large amounts of loss-absorbing capital (the money that comes from shareholders and retained profits).
The average ratio for the largest U.S. banks is currently 5.75 percent (using international accounting measures). This means they would all be insolvent if their assets collectively lost just 5.75 percent of their value. Such a scenario is not far-fetched: In 2008, banks needed government assistance equal to about 6 percent of assets. Under Hensarling's bill, the riskiest banks would have to roughly double the amount of capital they now have -- a positive development. The head of the Minneapolis Federal Reserve Bank, Neel Kashkari, today called for large banks to have 23.5 percent capital.
Hensarling's proposed changes to the structure of the Consumer Financial Protection Board are also probably necessary. An appellate court in October called the bureau "unconstitutionally structured" because the president can’t replace its executive director except for malfeasance, and its funds come not from congressional appropriations but through the Federal Reserve.
The unusual structure has insulated the agency from Wall Street lobbyists, yet it probably fails the Constitution's separation-of-powers test. Hensarling would impose the usual checks and balances by putting the bureau under a five-member bipartisan commission, like other regulatory agencies, and requiring it to get its funds from Congress.
But overall, the Texas congressman's bad ideas outweigh the good ones. Some of the Dodd-Frank law's essential pieces -- the stuff Wall Street most despises -- would be undermined, leaving the financial system dangerously exposed.
First, Hensarling would toss out the Volcker rule, which restricts speculative investments with taxpayer-protected bank deposits. Most banks have learned to accommodate the rule, despite years of foot-dragging and complaining, and the result is a safer system. Had it been in effect, it could have prevented JPMorgan's $6 billion loss in the London Whale fiasco, in which a trader gambled with such huge positions that he couldn't unwind the trades when they went sour.
Second, the congressman would eliminate the authority of regulators to bring shadow banks under their wing. Thousands of mutual funds, hedge funds, insurers, private-equity firms, high-frequency traders and other non-bank financiers are only lightly regulated. They don't, for example, have to follow bank-capital rules.
If anything, Congress should go in the other direction and improve regulators' ability to watch and tamp down risks as they are building. Money managers, like BlackRock Inc., whose $5 trillion in managed assets exceed those of JPMorgan Chase & Co., at $2.5 trillion, could be creating systemic risks to which regulators are blind.
Hensarling's third bad idea is to force insolvent banks to go through normal bankruptcy courts, rather than through Dodd-Frank's "orderly liquidation authority," which is a sort-of bankruptcy managed by the Federal Deposit Insurance Corp. The FDIC has the authority to borrow from the Treasury to keep a sick bank functioning as regulators wind it down, sell off the parts and pay creditors, to avoid a run on other banks. The failure of a giant institution, without the Treasury line of credit and the FDIC's decades of experience in shutting down insolvent banks, could trigger a global panic if the bank had to go through a normal bankruptcy.
Hardly a day passes without someone criticizing the Dodd-Frank law for burdening businesses with compliance costs, increasing financial instability and choking off bank lending. Sometimes what the critics really mean is that the law won't allow the financial industry to behave the way it did before the crisis.
Much of that activity wasn't illegal, but it is now. Some behavior was clearly illegal, leading to the banks' paying $177 billion in fines since 2010. It's a good thing that financiers can't do any of it again -- fingers crossed.
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