After having promised banks to get rid of Dodd Frank, which was never a strong enough bill to have a significant impact on profits or industry structure, Trump didn’t even back the House version of the bill to crimp Dodd Frank. But you’d never know that from the cheerleading from bank lobbyists upon the release of a 147 page document by the Treasury yesterday, the first of a series describing the gimmies that the Administration seeks to lavish on banks. As we’ll touch on below, the document repeatedly asserts that limited bank lending post crisis to noble causes like small businesses was due to oppressive regulations. We wrote extensively at the time that small business surveys showed that small businesses then overwhelmingly weren’t interested in borrowing and hiring. Businessmen don’t expand operations because money is cheap, they expand because they see a commercial opportunity.
But the even bigger lie at the heart of this effort is the idea that the US will benefit from giving more breaks to its financial sector. As we’ve written, over the last few years, more and more economists have engaged in studies with different methodologies that come to the same conclusion: an oversized financial sector is bad for growth, and pretty much all advanced economies suffer from this condition. The IMF found that the optimal level of financial development was roughly that of Poland. The IMF said countries might get away with having a bigger banking sector and pay no growth cost if it was regulated well. Needless to say, with the banking sector already so heavily subsidized that it cannot properly be considered to be a private business, deregulating with an eye to increasing its profits is driving hard in the wrong direction.
Nevertheless, despite faithfully repeating dubious bank taking points, the Treasury document isn’t as far-reaching as the headlines would have you believe. First, for the most part, it seeks to weaken already underwhelming post crisis reforms rather than undo them entirely. Second, the Treasury finesse is to focus on making changes that for the most part don’t require legislative approval. But even that isn’t likely to happen soon with Trump not having taking control of many parts of the bureaucracy. And some regulations aren’t easy to change.
For instance, banks actually do have some legitimate grounds for complaining about the Volcker Rule, and the Treasury devoted a section to it in this document. While its goal of not having the government support speculative trading by banks is correct, the idea of trying to draw a line between customer and proprietary trading was misguided. Banks routinely take positions to facilitate customer trades, and a “customer trade” can easily be gamed.
However, the bogus justification for weakening the Volcker Rule is that it has reduced market liquidity. First, that is merely (and always) asserted; the Fed hoovering up the most liquid securities, and the ones most often used for repo financing, namely Treasuries and top rated mortgage backed securities, played a big role. And more important, highly liquid markets are not necessary for commerce or investment. They are very useful for short-term speculators. Former Goldman partner, now Governor of the Bank of England, Mark Carney, debunked that notion in 2015. From a Reuters article:
Carney, in a speech Wednesday, argued that reduced market depth and higher volatility are part of a process with “further to run.”
“To be clear, more expensive liquidity is a price well worth paying for making the core of the system more robust,” Carney told an assemblage of City of London bankers at the Mansion House.
“Removing public subsidies is absolutely necessary for real markets to exist. Volatility characterizes such real markets and much of the pre-crisis market-making capacity among dealers was ephemeral.”
By contrast, anyone who understands how trading markets operate will recognize that this statement from the Treasury document is incoherent:
Maintaining strong, vibrant markets at all times, particularly during periods of market stress, is aligned with the Core Principles and is necessary to support economic growth, avoid systemic risk, and therefore minimize the risk of a taxpayer-funded bailout.
You can’t have ample liquidity at all times and not be propping up systemically important institutions when they get in trouble.
Treasury’s ideas for relief consisted of raising various bank size thresholds for compliance, giving “lenders” more trading latitude, and lifting the restrictions on how much capital banks can invest in their own private equity and hedge funds. Let us stress that there is no social purpose whatsoever for this activity. There is no shortage of asset managers. This is a pure gimmie. But the Treasury document goes on at some length to argue that banks need relief on “covered fund” rules so that they can set up more venture capital funds. VC funds back a whopping 1% of startups and on average perform even worse than private equity as a whole (the entire industry performance is due to the outliers at the high end).
On top of that, as Bloomberg stresses, it will be harder to get regulatory reforms than you’d think, particularly on the Volcker Rule:
It is not clear how quickly regulators can act on many of the recommendations in the Treasury’s 150-page report.
Key positions at the Federal Reserve, the Consumer Financial Protection Bureau and the Federal Deposit Insurance Corp. are either unfilled or held by Obama appointees. Also, the byzantine process for approving regulations doesn’t lend itself to quick fixes. Rules must be written, offered for public comment for several months and then deliberated internally before a final vote…
Some of the most unpopular regulations that the report asks to re-do, such as the Volcker Rule ban on banks’ proprietary trading, were put together by five different agencies. Each one would need to sign off on revisions following those onerous steps.
The Wall Street Journal echoed those issues:
The report marks the beginning of what will likely be a yearslong review of financial rules.
Some recommendations, including exempting small banks from the Volcker rule, limiting the consumer bureau’s authority, or expanding FSOC authority, would require congressional action—a potentiallyhigh bar amid deep partisan tensions on Capitol Hill.
Other changes would need regulatory approval from officials who might not be in place for months. Many bank rules must be approved by the boards of the Fed and the Federal Deposit Insurance Corp., but the leaders of those agencies have terms that haven’t expired yet. Mr. Trump also hasn’t nominated anyone to a number of significant regulatory roles, including the top bank oversight post at the Fed.
A senior Treasury official said most of the report’s recommendations could be carried out by regulators without help from Congress. The only current bank regulator appointed by the new administration, acting Comptroller of the Currency Keith Noreika, said Monday the report will inform his agency’s work aimed at reducing regulatory burdens at the federally chartered banks it oversees.
Another big hot button for the banks is the Consumer Financial Protection Bureau. With class action lawsuits, which historically had been the big check on bank grifting, largely neutered, the CFPB showed it could stop that sort of thing through its role in the Wells Fargo fake accounts case. Admittedly that came about a bit by accident; it was the Los Angeles Times and then the Los Angeles City Prosecutor, using the CFPB complaint database, that did much of the critical early spadework. And in fairness, regulators aren’t set up to go after bank frauds that are designed to rip off customers by small amounts unless they can find evidence in computer programs or other documents that provide a paper trail showing that it was institutionalized. Creating a culture where managers marched to largely the set of orders in absence of formal documentation made it particularly hard for any regulator to ferret out what was happening until the noise from customers got loud.
But the bigger point is the CFPB got lucky. The way the Wells Fargo scandal exploded into a big national story means bank whinging about the CFPB looks highly suspect. So Treasury isn’t backing House Financial Services Committee Chairman Jeb Hensarling’s scorched earth approach. However, one of the changes Treasury is pumping for, that of making the CFPB’s budget subject to Congressional approval, will be enough to render the agency toothless. Other major bank regulators are self-sufficient, making do off their fees and fines. By contrast, the CFTC, which is generally seen a secondary regulator, and the SEC are kept on a short leash by Congress through the budget process. The SEC, which was a feared and respected agency when I was a kid on Wall Street, has become a joke as a result. For instance, Arthur Levitt, the SEC chairman under Clinton, recounted how he was regularly threatened by the Senator from Hedgistan, Joe Lieberman, for any weak efforts to protect retail customers.
I know I should probably debunk some of the many canards in the Treasury document but every page is thick with them, and even going after one takes about three times as many words as it does to purvey the bogus spin. For instance, one canard is blaming less mortgage lending and in particular, the dependence of the mortgage market on government guaranteed loans, on those nasty post crisis regulations.
First, before the crisis, about 40% of the mortgage originations were subprime. And 75% of those were securitized, so banks didn’t keep them.
The reasons that market hasn’t come back is due to the lack of regulations. This is one of those few cases where investors were so badly burned that they were leery of getting back in the pool in any serious way for years.
Back in 2010, he FDIC proposed four changes to subprime origination needed to satisfy investors. The securitization industry refused to support them. That was far and away the biggest constraint on mortgage lending in the years after the crisis.
The new rules do require borrowers to submit more paperwork. I find the complaints remarkable given the sort of documentation I had to provide when getting mortgages in the 1980s. And why is it airbrushed out of collective memory that as early as 2006, the FBI estimated that up to 70% of early payment defaults were due to misrepresentations on loan documents? More stringent documentation makes that a lot harder. Behavioral psychologists also pointed out that the ease of getting mortgages, and supposedly expert banks’ eagerness to tell borrowers they could afford even bigger houses helped induce borrowers to get in over their heads (I didn’t take cabs all that often in 2007 and 2008, but when I did, especially outside NYC, I frequently had the driver volunteer that a banker tried to get him to buy a bigger house than he knew he could afford).
Lenders were also more stringent about borrower FICO scores even for prime (Fannie/Freddie) mortgages. But the big cause was not all that supposedly pesky Dodd Frank paperwork. Georgetown law professor Adam Levitin debunked that yesterday for us, summarizing his Congressional testimony:
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.
So if it wasn’t Dodd Frank, what was led the banks to focus so much on high FICO score borrowers? It was mortgage servicing reforms, which made it hard to foreclose due to stopping abuses, like dual tracking (continuing to foreclose even when supposedly considering a mortgage modification).
To look at the bigger picture, it’s hard to take bank complaints about oppressive regulation seriously in light of this:
And if you had any more doubts, reader JGK gave some additional color in comments:
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.
Consistent with what Levitin said yesterday, the small bank campaign against Dodd Frank isn’t about their economics. It’s largely ideology. It’s one thing to have a Republican Administration spinning otherwise. But shame on the press, which ought to have figured that out by now.