Trump, Republicans Make Bogus Case for Bank Deregulation as Senate Certain to Curtail House Dodd Frank “Reform”

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
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  1. vlade

    What I’d like to really see is how/whether US is considering the Basel 3 new Market Risk capital regulations (aka FRTB). This is a rather large part of the regulation, and is quite different from the current version. If I was to put it into a catchy slogan, it would be “complexity costs capital” (and that’s any sort of complexity, from system, to product to you-name-it).

    For example, it’s likely that it would put a significant cramp on single-name CDS markets (for reasons too onerous and technical to fit into a response here – but Yves, if you’re interested, let me know and I’ll write a long-form email).

    The problem with that is that EU has already started watering it down and tinkering with it (after heavy lobbying by its banks), and who knows what’s going to happen to it – it could end up as an absolute hodgepodge of stuff that is very complex and unworkable. It’s complex as it is now, but I know that some of the EC tinkering has alrady opened gaps that could be used to play the regulations.

    No-one knows what will happen in US to this, even though some of the banks (IIRC Morgan Stanley) said they would want it implemented in the US as well. But even if US decided to implement it, the tinkering details (as per the EC example.. ) will matter.

    1. Yves Smith Post author

      I can ask around. My gut is that the Trump Administration is so thinly staffed and so fixated on being able to say they delivered on campaign promises that this is not on their radar. But maybe this is too important for them not to address, even in their “stretched too thin” mode.

      I woud like to know re CDS, this is a pet hobby of mine. Thanks for the offer.

  2. John Wright

    The article mentions a potential Trump appointee, David Malpass.

    I remember him from a past editorial he wrote before the housing bubble pop..

    He is the former chief economist of Bear-Stearns, so one hopes he knows financial leverage well.

    I saved an electronic copy of an editorial Malpass wrote in a 2005 Wall Street Journal.

    Malpass wrote on March 29, 2005 for the WSJ that the USA is building assets faster than debt and that household net worth reached $48.6 trillion in 2004. Then he mentioned “On a per capita basis, net financial assets total $89,800 in the US vs $76,000 in the No. 2 saver Japan, Of course, some households don’t have nearly this average, creating risks for them and burdens on others in the event of a downturn.”

    Whenever someone states “averages” rather than “medians” in an unequal society, it well could be an indication they are hiding problems at the median level..

    For example, perhaps the average US financial firm in 2008 was not highly leveraged, but Mr. Malpass’s firm, Bear-Stearns was, which created, to use Malpass’ words, “risks for them and burdens on others in the event of a downturn”.

    As Chief Economist of Bear Stearns, did Malpass foresee problems with Bear-Stearns before it blew up in 2008?

    Here is more information on this Trump appointment.


    ” In 2007, before the housing market collapse, Malpass wrote for the Wall Street Journal that “Housing and debt markets are not that big a part of the U.S. economy, or of job creation…the housing- and debt-market corrections will probably add to the length of the U.S. economic expansion.””

    Malpass has made a career of being wrong and not foreseeing problems, but has survived by advocating what the financial elite want to occur.

    It works for him as he moves from the ashes of Bear-Stearns in 2008 to a possible position as Trump appointee overseeing international policies.

    Perhaps this is another indication Trump is having a difficult time finding people to work for him.

  3. Scott

    Far as I understand it modern banks want the people to finance their sandbox. Finance banking has an interest in crisis which is an opportunity to collect deeds.
    The people are used to banks abusing them and don’t demand they be regulated as a utility.
    Further the sandbox has no rules and ignorance is great so as the agenda of the powerful is privatization the people don’t even see the offer of USPO Service Banking as serious.

  4. lyle

    The house bill has an interesting feature raise your capital to 10% without risk adjustment and you can avoid a lot of regulation. Of course it has always been clear with enough capital a bank can be much safer because the investors take the loss. I might go a bit higher but it is essentially a piece of the Kashkari proposal. One other thing is to create a second class of stock that is assessable, or alternativly make the investment bank section a partnership with partners liable to their last penny as it used to be in investment banking. There could be a public limited partner which would not be so liable. This would mean that in good times the bank would have the capital it needs, but in bad the partners would take a bath.

    1. Yves Smith Post author

      That feature is not expected to survive the Senate, which is why I didn’t mention it. That’s also why putting it in the House bill was cynical. It served to justify the not-easily or not-at-all justified Dodd Frank changes as “Look, the capital solves it all, why worry about the rest?” when the banks would never let that provision stand in a final bill. From the Wall Street Journal”

      That means the Senate is unlikely to take up some of the more controversial provisions in House bill, according to a GOP Senate aide, such as the 10% leverage ratio for regulatory relief, reduced powers of the consumer bureau, and repealing the Orderly Liquidation Authority in Dodd-Frank for the government to unwind a failing financial firm.

  5. Left in Wisconsin

    Nobody wants to be identified as the Goldman Sachs candidate in the next election…

    This is really typical FT naiveté. What happened in this last US election? The Goldman Sachs candidate lost, the anti-Goldman Sachs candidate won, and Goldman Sachs continues to run the government.

    It’s almost as if they don’t want to see what is right in front of their face.

  6. Left in Wisconsin

    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. … Despite that movie having ended badly, banking regulators in the post-crisis era have copied that approach.

    These would be stories worth telling. Perhaps someone has already?

  7. Edward

    William Black was very critical of Dodd-Frank. I wonder if his views have changed or if his fears have been born out.

      1. Edward

        Black had some specific criticisms which I don’t recall. I am curious if what he predicted would go wrong did go wrong.

        Even if Dodd-Frank did some good, the fact that this weak brother of Glass-Steigal was the best Congress could produce after a world-wide economic calamity is sick. This was probably the minimum they could do without provoking a public backlash. After the Great Depression, Congress had enough sense of decency (or a more alert public to fear) that it voted itself a pay cut and enacted uncompromising reforms.

        As pathetic as the U.S. response has been, Europe seems to have done even worse with its austerity.

  8. JGK

    As a former DC lobbyist for a credit union trade association, I can verify that all the trades are getting behind Dodd-Frank repeal, even if it only marginally benefits their members. At this point, these decisions are far more political than practical. They went to get in good with the Republican majority and punch back at CFPB for keeping them accountable. And the compliance costs at this point are baked in. Just about all of the regulations emanating from DF are fully in effect and the compliance costs have already been imposed. Repealing these regulations wont save any money for institutions, since all their compliance systems are already in place. In fact, repealing regulations that are already in effect can actually cost banks, since they need to go back and make changes again.

    As for the exam threshold, the big banks have more than enough resources to deal with an additional CFPB exam, especially given that the prudential regulators are focused on a million other issues, least of which is the growing concern over cybersecurity and credit card hacks.

    Needless to say, the stupidity coming from the banking trades and their Republican socio-hacks is one of the main reasons I left Washington.

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