We’ve argued from the crisis onward that the limited re-regulation of banking that took place was inadequate. But the Republicans are whinging that banks nevertheless are being treated badly despite a lack of evidence behind virtually all of their claims.
The effort to give already-overly-coddled banks an even better deal is lumbering forward. The House last week passed a “Financial Choice” Act which sought to dismantle large parts of Dodd Frank. We won’t dwell on that because the Senate is certain to nix large portions of it. However, as we were drafting this post, the Wall Street Journal published a story saying that the Trump Administration is supporting one of the worst ideas in this bill, that of cutting back the power of the Consumer Financial Protection Bureau. From its account:
The Trump administration will recommend limits on the U.S. consumer-finance regulator and a reassessment of a broad range of banking rules in a report to be released as early as Monday, according to people familiar with the matter.
The report from the Treasury Department, drafted in response to a February executive order from President Donald Trump, is less sweeping than financial legislation approved by the House of Representatives last week, these people said…
The report is around 150 pages and makes recommendations on policy goals, without laying out a specific process for achieving them, these people said. It is harshly critical of the Consumer Financial Protection Bureau and recommends that the bureau be stripped of its authority to examine financial institutions, people familiar with the matter said. By law, the bureau has the authority to enforce consumer laws as well as to examine individual firms on a continuing basis.
One person familiar with the report’s contents said it is likely to recommend that the CFPB continue to be led by a single director, but that the president be able to remove the director at will.
Yves here. It’s going to be interesting to see how exactly the Treasury lambastes the CFPB given that the Wells Fargo fake accounts fraud would never have been blown open in the absence of the CFPB’s complaint database. It might try to ding the CFPB for not having found it through its exams, but exams are not designed to find penny-ante frauds, even when executed across huge numbers of customers. And if the CFPB is faulted for not finding it, the remedy would seem to be giving it or some other regulator even more intrusive exam authority.
Put it another way: it’s not going to be hard for consumer advocates to make a case against the Treasury’s likely arguments to editorial boards.
The Journal reports that the Treasury document will recommend that banks with less than $10 billion in assets be exempt from the Volcker Rule and includes a section on what bank regulators could to on their own. This is particularly important since the recent Fed governor in charge of large bank supervision, Danny Tarullo, fought the banks hard to get some important reforms implemented, the most important being higher capital levels.
John Dizard of the Financial Times over the weekend pointed out that opponents of bank deregulation may be missing the real game by focusing on the effort to roll back Dodd Frank rather than the Administration’s planned Fed appointments. From his article:
Yet one part of the administration’s programme, financial deregulation does appear to be making progress…
Financial deregulation is not entirely dependent on a repeal of much of the last administration’s Dodd-Frank law….much of Dodd-Frank will remain. Nobody wants to be identified as the Goldman Sachs candidate in the next election…
Trump appointments to the Federal Reserve Board and to executive-branch financial regulatory positions are, so far, following someone’s coherent plan…
If they pass through Senate confirmation, appointed officials such as David Malpass and Adam Lerrick, who would oversee the administration’s international policies, and Randal Quarles, the prospective vice-chairman for supervision of the Fed, will have a great deal of discretion in how they apply laws and regulations. Both Mr Malpass and Mr Lerrick are outspoken supporters of Schumpeterian creative destruction, and opponents of most US government or IMF bailouts.
The “creative destruction” argument serves as justification for “Let them carry on. If they blow themselves up, no one will try that again.” The problem is that all of this “let the chips fall where they may” talk tends to go by the wayside when the financial markets are imploding.
And that’s before we get to the bigger problem: that these assertions that banks need more waivers, gloss over the fact that what is good for banks is typically not good for the broader economy. Highly profitable banks are rentiers. The Japanese recognized that well in their heyday.1 Regulators and the general public understood that too-well-remunerated banks were a drag on commerce.
In Case You Need Reminding, Why Bank Re-Reregulation Did Not Go Far Enough
The officialdom has managed to draw a veil over the fact that the rescue effort, both in immediate costs, and the ongoing transfer from savers and distortions to the economy resulting from sustained negative real interest rates, is the largest looting of the public purse in history.
And in terms of the ongoing danger that modern banking represents to the public’s economic health, a back-of-the-envolope calculation by Andrew Haldane, then the Director of Financial Stability for the Bank of England, can’t be repeated too often. A recap from a 2010 post:
More support comes from Andrew Haldane of the Bank of England, who in a March 2010 paper compared the banking industry to the auto industry, in that they both produced pollutants: for cars, exhaust fumes; for bank, systemic risk. While economists were claiming that the losses to the US government on various rescues would be $100 billion (ahem, must have left out Freddie and Fannie in that tally), it ignores the broader costs (unemployment, business failures, reduced government services, particularly at the state and municipal level). His calculation of the world wide costs:
….these losses are multiples of the static costs, lying anywhere between one and five times annual GDP. Put in money terms, that is an output loss equivalent to between $60 trillion and $200 trillion for the world economy and between £1.8 trillion and £7.4 trillion for the UK. As Nobel-prize winning physicist Richard Feynman observed, to call these numbers “astronomical” would be to do astronomy a disservice: there are only hundreds of billions of stars in the galaxy. “Economical” might be a better description.
It is clear that banks would not have deep enough pockets to foot this bill. Assuming that a crisis occurs every 20 years, the systemic levy needed to recoup these crisis costs would be in excess of $1.5 trillion per year. The total market capitalisation of the largest global banks is currently only around $1.2 trillion. Fully internalising the output costs of financial crises would risk putting banks on the same trajectory as the dinosaurs, with the levy playing the role of the meteorite.
Yves here. So a banking industry that creates global crises is negative value added from a societal standpoint. It is purely extractive.
Back to the present post. Dodd Frank fell vastly short of the needed reforms. It didn’t curb one of the most glaring subsidies to large-scale risk taking, that of allowing banks to use deposits to fund derivative positions. It did nothing to rein in credit default swaps. CDS have virtually no social utility and yet directly responsible for turning what would otherwise have been a somewhat-worse-than-S&L-level-crisis-housing-bubble-unwind crisis into a near-failure of the global financial system.2 Many of its provisions were subject to studies and/or rulemaking, which would give the financial services lobby another go at weakening the reforms. And better yet, that would happen largely out of the eye of the general public.
Having said that, some of the measures were not well conceived. For instance, while the goal of the Volcker Rule, that of not having the government fund speculative trading, is sound, the idea of parsing out “customer trading” from “proprietary trading” was misguided. Any time a bank takes a large position to facilitate a big customer trade, i is taking a proprietary trade. And what amounted to a “customer trade” could readily be gamed.3
Why the Recent Arguments for Bank Deregulation Are Spurious
We’ve discussed repeatedly why the big claim that Trump and other have made, that regulations are preventing banks from lending to small businesses, are spurious. First, as we’ve recounted in real time over the years, small businesses haven’t been in the market much for loans because they don’t see opportunities to expand their companies. Second, aside from the larger small businesses (established track records with annual revenues >$4-$5 million), major banks, with their branches operating as retail “stores,” have abandoned the small business market.
Professor Adam Levitin of Georgetown Law School, an expert in securitization and payment systems issues, gave testimony last week in the House on the Dodd Frank reform bill. We’ve embedded it at the end of this post (you need to move your cursor to the very bottom of the embed for the navigation bar to appear). It has juicy geeky factoids in it, like the fact that banks could use a proposed portfolio lending exemption to the Ability to Repay requirement to use derivatives to dump credit risk on Fannie and Freddie. Mind you, that pre-supposes that letting banks lend to people without determining if they can repay is a good idea.
Levitin was kind enough to recap his testimony in lay-speak via e-mail.
(1) Small banks are doing really well since Dodd-Frank. Their ROE has was surpassed the S&P 500 and more of them are profitable than at any point in the last 20 years. There’s continued consolidation, but the pace of consolidation didn’t change at all with Dodd-Frank: something like 250 banks/year disappear.
(2) There’s no question Dodd-Frank increases some compliance costs for banks. Some of those are one-time increases, like the switch to the TILA-RESPA Integrated Disclosure (TRID) for mortgages, and getting used to QM compliance. None of these should be game-changers for small banks, however. If their margins are so thin that they can’t absorb the costs of compliance under a stricter regime, there’s a problem, but it isn’t compliance costs; it’s their business model.
(3) There are lots of reasons unrelated to regulation why small banks are having problems, first and foremost that the lack economies of scale, secondarily that they aren’t geographically diversified in their exposures, and thirdly that they are often family owned and have generational succession problems. The banking lobby doesn’t have anything it can do to help on these points, however, so it focuses on regulation. This despite an FDIC study that found that 80% of the P&L of small banks is determined by macro conditions with 20% being regulation plus a whole bunch of other things.
(4) If we’re going to look at costs, we also need to consider benefits. Dodd-Frank was a package deal. Dodd-Frank resulted in a bunch of benefits for small banks: (a) lower FDIC premiums for depositories under $10B, (b) Durbin interchange amendment exemption for consolidated groups under $10B, (c) exemption from CFPB supervision and enforcement for depositories under $10B, (d) exemption from stress testing for consolidated groups under $10B. The first item is an absolute benefit, while the latter three are competitive advantages relative to bigger banks.
(5) The trade associations for the small banks are carrying water for the big boys. NAFCU, for example, is lobbying for amendments such as repeal of the Durbin Amendment and raising the CFPB examination/enforcement threshold to $150B, that would benefit all of 3 of its thousands of members and would cost its smaller members a competitive advantage. ABA is lobbying for raising Dodd-Frank’s heightened prudential standards from $50B to $500B, even though big bank failures inevitably hurt small banks. I don’t know when the small banks are going to get that their trade associations aren’t acting in their interest. I’ve seen this go one for years now, and it’s so frustrating.
(6) Some of the stuff the small banks are whining about doesn’t hold up. For example, they’re very upset about the additional 24 data fields they have to collect under the CFPB’s new HMDA rule. That sounds like a lot until you look at the fields required and realize that all but one of them are already being collected either for underwriting purposes (e.g., the street address of the collateral property) or for the TRID (e.g., the broker’s NMLSR number) or both. The sole exception is the borrower’s age, which would be collected for a reverse mortgage underwriting, in any case. It should take a lender all of perhaps 5-7 minutes per loan to collect and enter the data into a computer program. The CFPB thinks the compliance burden will translate into 143-173 hours of additional time per small institution. How this is a major compliance burden absolutely baffles me. And no one bothers to mention that the new rule exempts 1400 institutions (mainly small banks) that currently report data and covers some 450 that don’t (primarily nonbank). Put another way, the discussion has almost nothing to do with facts.
(7) There is a real concern about access to banking services for rural (and poor urban) communities. But broad regulatory exemptions don’t solve this problem (where the generational transition issue is particularly acute). I suspect that the only solution will be some sort of duty-to-serve requirement for larger institutions, mandating service to rural markets if they serve large ones. It’s the banking equivalent of rural broadband.
(8) Without regulation, small banks wouldn’t exist. The reason there are so many in the first place is a legacy of interstate branch banking restrictions, and without FDIC insurance, they’d all be gone because they’re too hard for depositors to monitor. They add a lot of value to the financial system, however, so we should be trying to find ways to help them, but not at the cost of consumer protection or financial stability.
Levitin’s point about the intensity of small bank lobbying efforts on behalf of the big boys is real. One reader in comments had gotten a pitch from his credit union asking for him to pump for getting rid of Dodd Frank because it was allegedly costing the bank and therefore customers real money. Please read Levitin’s testimony for more detail as to why that is all wet.
Unfortunately, with the Democrats fixated on the scary Putin monster as their key to reelection, it’s an open question as to how hard they will fight to block some of these unjustified gimmies to banks.
1 Before you pooh-pooh Japanese regulators, the Japanese crisis was in significant degree due to rapid deregulation of banking, which was forced on them by the US. A second cause was decision by the Bank of Japan to cut interest rates even though the economy was strong, to goose asset prices and create a wealth effect to prod Japanese consumers to spend more. Despite that movie having ended badly, banking regulators in the post-crisis era have copied that approach.
2 See Chapter 9 of ECONNED for details.
3 It would have been much cleaner, and a much better proxy for when banks were taking speculative bets, to use Value at Risk measures. This instance is one where VaR would have given a good assessment.Levitin Senate Banking Testimony 6-8-17-2