Jeb Hensarling, now the chairman of the House Financial Services Committee, has long had Dodd Frank in his crosshairs under the dodgy premise that it put lots of burdens on banks. Putting aside the fact that Hensarling would take this position irrespective of whether it was true, bank noise-making on this front has to be taken with a fistful of salt, since their baseline is that any restriction on
their ability to loot and pillage their freedom of operation must be beaten back on principle, even if it might be for the good of the institution.
Andrew Haldane of the Bank of England described why banks need to be curbed in his 2010 speech, The $100 Billion Question:
Tail risk within some systems is determined by God – in economist-speak, it is exogenous. Natural disasters, like earthquakes and floods, are examples of such tail risk. Although exogenous, even these events have been shown to occur more frequently than a normal distribution would imply.24 God’s distribution has fat tails.
Tail risk within financial systems is not determined by God but by man; it is not exogenous but endogenous. This has important implications for regulatory control. Finance theory tells us that risk brings return. So there are natural incentives within the financial system to generate tail risk and to avoid regulatory control. In the run-up to this crisis, examples of such risk-hunting and regulatory arbitrage were legion. They included escalating leverage, increased trading portfolios and the design of tail-heavy financial instruments.
In other words, individuals in financial institutions will take risks because more risk means more upside. And since the upside goes to the employees and bosses, and catastrophic losses fall on society at large, financiers have every incentive to take as many gambles as they can get away with.
But Trump in his Presidential campaign repeatedly claimed that Dodd Frank was hurting growth by constraining bank lending. This view may be due to Trump embracing bog standard Republican ideology about the evils of regulations, or may be based on his self-serving belief from his days in real estate that loans are always more trouble to get than he’d like and banks ought to be delighted to hand over money to him. Obviously, some evil force was getting in the way.
On a high level, the idea that Dodd Frank has a macro impact on lending is dodgy. For starters, big corporations use bank loans only for limited purposes, such as revolving lines of credit (which banks hate to give but have to for relationship reasons because they aren’t profitable) and acquisition finance for highly leveraged transactions (and the robust multiples being paid for private equity transactions says there is no shortage of that). Banks lay off nearly all of the principal value of these loans in syndications or via packaging them in collateralized loan obligation. They are facing increased competition from the private equity firm’s own credit funds, which have become a major force in their own right.
Otherwise, big companies rely on commercial paper and the bond markets for borrowing. And with rates so low and investors desperate for yield, many have been borrowing, for sure….but not to invest, but to a large degree to buy back their own stock.
And as we’ve reported, small businesses in the post crisis era haven’t been keen about borrowing due to weak overall demand. Entrepreneurs don’t borrow and expand because money is cheap; they borrow because they see an business opportunity and think they can exploit it.
In addition, even in the areas where growth has been strong, there’s a much bigger impediment to small business lending: contra Trump and Hensarling, banks have almost entirely abandoned that business. Banks quit training credit officers who could assess idiosyncratic small business in the mid-later 1980s and turned branches from free standing little businesses under a branch manger into retail stores that open bank accounts and sell lending products to mass customers.
But even with this 50,000 foot view, could Trump and Hensarling nevertheless have a valid critique of Dodd Frank, in terms of it constraining lending in certain economically important niches? After all, many would assume that because the banks all got high before the crisis and made a whole bunch of reckless real estate loans that Dodd Frank throttled that down. Even if you think that’s an entirely desirable outcome, the Republicans could then claim that Dodd Frank did in fact reduce lending, leaving the experts and ideologues on both sides to argue whether the line was drawn in the right place or not.
A Financial Times article today does the important service of examining the bigger question of whether Dodd Frank curbed growth. The bottom line is it can’t find much evidence to support that claim. And even though residential real estate lending in particular did become more stringent after the crisis, Dodd Frank had almost nothing to do with that.
Mind you, the article, Did Dodd-Frank really hurt the US economy?, doesn’t even factor in the issue we raised earlier, that the bad incentives inherent in the financial services industry and its demonstrated ability to blow up the real economy means that even if there were a near-term economic cost to having banking be safe and boring, the cost of financial crises is so high you’d still come out ahead in the long term.
The headline data do not suggest that loans are too hard to obtain. Figures from the Federal Deposit Insurance Corporation show that gross loans across the US’s commercial banks have grown pretty steadily for at least three years, spread across all categories except home-equity lines of credit and loans to other banks…
“Loan growth remains robust,” said Marianne Lake, his counterpart at JPMorgan Chase, while presenting record annual net income of $24.7bn last month.
But what about particular products and niches? Remember all those bitter bank complaints about the evils of Dodd Frank mortgage requirements? The article acknowledges them but observes:
But Laurie Goodman, co-director of the Housing Finance Policy Center at the Urban Institute, a liberal think-tank, argues that other factors have had a greater effect.
Credit remains “extremely tight”, she says, because lenders are worried by the representations and warranties they need to make to Fannie Mae, the government-sponsored mortgage buyer, and the high cost of servicing delinquent loans, among other factors. None of that was in Dodd-Frank.
In her former life at Amherst Securities, Goodman was a, if not the, top mortgage analyst. She is a hard-core data nerd. She’s not the sort that would take a position if she could not substantiate it well, and her standards are high. So one should take her reading seriously.
It is hard to reach any conclusions for small business loans:
Small-business lending is a mixed picture too. Non-mortgage loans of less than $1m to non-farm businesses peaked at $375bn in 2007, according to FDIC data, and have since fallen to $284bn.
To Douglas Holtz-Eakin, president of the American Action Forum, a centre-right think-tank, that is a sign of the extra burdens of compliance.
But other analysts say it is hard to disentangle Dodd-Frank effects from extra caution as banks rebuilt capital; a relatively sluggish economy; and competition from a host of nonbank platforms. Some note that the main piece of Dodd-Frank targeting small-business loans ― which requires banks to collect and report more data ― has yet to take effect.
Even if the evidence of Dodd-Frank hurting bank lending is unpersuasive, says Michael Barr, a professor at the University of Michigan, that will not stop Republicans determined to unwind it….
He notes that lobbyists are already talking about scrapping the Volcker ban on proprietary trading, and abolishing the Financial Stability Oversight Council, which was supposed to monitor risks developing outside the deposit-taking banks.
None of this has much to do with easing the flow of credit.
The only place where the Dodd Frank critics might have a case is in credit cards:
In products such as credit cards and personal loans, for example, analysts say activity has been damped by fear of censure by the Consumer Financial Protection Bureau. The CFPB was one of the agencies spawned by Dodd-Frank; it enforces 19 federal consumer protection statutes covering everything from home finance to student loans, credit cards and banking practices.
Dodd-Frank ordered the agency to look out for “unfair, deceptive or abusive” practices in any financial product or service offered to a consumer.
That may have caused banks to be wary of customers on low incomes and with thin credit files, says Justin Schardin, director of financial regulatory reform at the Bipartisan Policy Center. He cites a study last year showing that customers with non-prime credit scores were awarded less than one-fifth of new credit-card accounts in 2015, down from 29 per cent in 2007.
However, this is dodgy. Numerous studies have found that high levels of consumer borrowing are strongly correlated with lower economic growth. High levels of private credit growth are now widely understood to increase the risk of financial crises. And in the last two years, more and more economists have concluded that overly large financial sectors dampen growth. The IMF concluded in 2015 that the optimal level was roughly that of Poland. And they concluded having a more significant banking sector was a plus only if it was well regulated.
So if curbing credit growth is a good idea (for everyone but banks), the place to start would be the riskiest and least economically productive loans. Credit card lines to weak borrowers would be high on the list.
So the common sense conclusion, that Dodd Frank can’t have done much if any harm because it didn’t change all that much, is borne out by a look at the data and related considerations. But even mild pro-safety measures are too much for the deregulation-mad Republicans.