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.
Thank you, Yves.
It’s not just “deregulation-mad Republicans”. There are neo-liberals in the three main European political groupings (Christian Democrat / Conservative, Liberal and Socialist / Labour) itching to do so.
As soon as Trump talked about and then ordered the review of Dodd-Frank, the media and financial analysts has been speculating about the “high water mark of regulation”, the “swing of the pendulum” and the pressure on European, including British, to “ease or back off”. The worst, IMO, is City AM, a free sheet given away each morning in London.
I am glad that you mentioned Andy Haldane. Unfortunately, he is unlikely to become governor. My money is on Tory grandee and aristo, Charlotte Hogg. She has just been made a deputy governor. Perhaps, one should be grateful for the small mercy that Treeza is unlikely to appoint a City banker, especially one from Goldman Sachs.
Yves, thank you for this concice reply to his comments. On this point I have three comments:
Why can’t it be both? When he had his bromance moment with Jamie Dimon he presented it in the personal (paraphrasing) “I have so many friends who can’t get loans because of Dodd Frank.” This seems to be a consistent pattern for him and it is consistent with the way he presents most things in the royal I. But given his legal troubles over the years I am not surprised that he would hate regulations with a passion.
That said this will probably play well in Peoria. As a private citizen, pre-2008 I had people falling all over themselves to lend me money. Now those bulk mailings have dried up, and I didn’t do anything different. Dodd Frank probably didn’t cause that alone but post hoc ergo propter hoc always sounds good on the talk shows.
or that he would have a problem getting a loan. banks and others tend to look down at potential debtors who file bankruptcy. a lot
With regard to “their ability to loot and pillage their freedom of operation”, some, if not many, of the bankers et al I work / have worked with gave the impression that they have / had a “divine right of kings” to do so as they are “super smart”, went to the right schools and universities, pulled themselves up by their bootstraps, work hard / long hours etc. Such types are around and waiting for the opportunity.
“With regard to “their ability to loot and pillage their freedom of operation””
My experience is that this sort of baseline thinking is not limited to banks. Rather, most of the private sector seems to think this way, in the USA, medium and large enterprises. Having spent my entire life in privately held medium size outfits and dealt directly with the upper class, I have heard more than one of them state that its only illegal if you get caught.
The Glass–Steagall Act of 1933 was just 5-6 pages long, and it basically divided commercial banks from high risk investment banks that wanted to gamble on more high risk ventures? The problem is the The Dodd Frank legislation is over 2000 pages long and is very complicated. Also, it has had the effect of shutting down local commercial banks through over regulation. The very opposite to what is wanted.
What is needed is many more local independent banks that are detached from the big boys on Wall Street. A relatively simple act of a few few pages worked for nearly 70 odd years. Why over complicate things?
Sometimes it looks as if the politicians regulate for the purpose of reducing competition for the big boys.
Minor point: the Glass Steagall Act was 34 pages long. See:
Aside from that cavil, I enthusiastically agree with you about the value of Glass Steagall. The Republicans promised to restore it; I wonder what the chances are of that actually happening? Here’s the relevant text from page 28 of the 2016 Republican platform:
Thanks Vatch for correcting me about the 34 pages, my point being it was a simple piece of legislation, and did the job for 70 odd years quite well. And I agree they should bring it back or something similar.
You either regulate investment banking which bankers hate because it limits their freedom to take risks or you deregulate them, but with the proviso that if they bankrupt their own bank, then tough, no bail outs.
We created the worst possible system. We deregulated them so they could carry out risky transactions, and then gave then the protection of total bail outs. To do this you need a healthy banking system for the little guys to be able to deposit their life savings, and perhaps borrow for a mortgage or small business without the high risk that people will lose all their money.
Complex regulation is weaponized to assist large companies and special interest groups. If you can keep competition out simply by making start-ups difficult, time-consuming, and expensive then you can charge more with less competition.
It happens at all levels from professions to banking regulations. The big banks may want to some rules lifted (especially the CFPB and the fiduciary rule) but in general they have the resources to deal with a complex regulatory environment. Small firms have to spread the same compliance costs over a much smaller asset base, so its margins are lower.
The last thing in the world big banks want is a simple 40 page regulation that restricts their capital ratios and prevents them being in some markets.
Sally and DH, you are both correct. It’s a mess, and the leaders of both political parties have little incentive to fix it. I hope we can embarrass some Republicans enough so that they really do try to fix it — the fix was in their platform, after all.
Thank you, Sally. Oh, yes. The lobbyists make sure that a barrier to entry is erected. That is one of the dirty secrets of the trade.
the reason laws are so much longer is that business doesnt really like uncertainty, which means that they have to go court to find out what the law means, and they spend money to do that, with a much more detailed law, you can skip that for the most part. after all, legislatures could just tell us to not go to faster than it was safe to go. but then we would end up in court tying to determine what that means.
It’s good that Yves mentions Poland.
At HSBC from 2003 – 6, I worked on Polish transactions. HBPL operated as a branch, but had to convert to a subsidiary when the bank sought local / retail funding. That was a condition imposed by the Polish authorities. It was the same in Russia (HCRR).
The Polish authorities are wary of foreign dominance of their banking system and not taking chances with regard to deposits, especially retail. Poland insisted on (retaining) the ability of local regulators to adapt the European iteration of the Basel accords, CRD / CRR, to local conditions, especially establishment.
This article misses what I consider to be a key point.
I feel that the biggest issue with Dodd-Frank is the concentration of larger banks. In 1990, the five largest banks held 9.7% of the industry’s total assets. 2008 it was over 33%. Today it is 44% and continues to grow. Community banks in total own approximately 20% and that share is declining at a much faster rate since 2010.
Personally, my community bank has been bought out twice since Dodd-Frank. I have acquaintances working for small banks who reaffirm my belief that the additional regulatory cost caused by Dodd Frank will only solidify the Too-Big-To-Fail structure that we’ve seen internationally.
Community banks serve a disproportionately high number of commercial loans for small businesses, agriculture and residential mortgages.
Building a more robust and competitive banking structure isn’t what Dodd-Frank has accomplished. It certainly didn’t hold any of the bank executives responsible for careless lending practices. America needs to find a solution, I think someone outside of the Big five’s pockets is the right place to steer the ship. This issue transcends political affiliation.
Dodd-Franks didnt create the concentration of banks. the ever popular free market, along with acceptance by regulators did that
Small banks are over burdened with the regulations that are slapped on them that are designed to go after the big boys.
I’d rather simply exclude them from some of the regulations than give the Goldmans et al free reign.
This is a place where the Trumpster will loose support from independents … if he doesn’t stay true to draining the swamp..
too late. he has already stopped the drain the swamp pledge, after all , his cabinet is made up of billionaires and some less dubious others.
The big banks have been using small banks to lobby on their behalf. This is so prevalent that it has been reported several times in the press.
You believe what amounts to big bank PR.
If Glass Steagall were still in place, we wouldn’t be seeing this allegation. Another big thanks to the DLC collaborators.
My gripe with Dodd-Frank is that it did away with a seventy-year old registration exemption for investment advisors who had fifteen or fewer clients–all of whom were ‘qualified’, i.e…rich. Generally those sorts of advisors had profit incentive arrangements with their clients. Phil Fisher, of ‘Common Stocks and Uncommon Profits,’ was one such advisor.
The alternative to this sort of arrangement is the hedge fund. I think this is worse for the client. Why, because it exposes the client to the needs and fears of the hedge fund’s other limited partners. If a big limited partner heads for the exit, it’s almost guaranteed that the other limited partners will end up with a less liquid portfolio. Hedge funds are exempt from registration if they manage less than $100 million in assets.
Eliminating this registration exemption was just bureaucratic overreach. People who are as smart as Phil Fisher are rare. They could easily just manage their own money. They hate filling out forms.
I could not agree more with your conclusions Yves and have written as much at The Crime Report. Link here
I could not agree with your conclusions about the roll back of Dodd-Frank that had not done much of anything and I have written as much, Corporate Crime in An Age of Trump, for The Crime Report on Feb 8th. Link below:
Don’t blame Trump. Obama had the banking industry by the balls. Geithner and Paulson help him let go. They could have bought back Glass Siegel. Now well all pay again.