Big Wall Street banks caused a financial crisis and brought the nation to the brink of economic collapse; President Obama signed the Dodd-Frank Act to punish those banks and end government bailouts of too-big-to-fail financial institutions.

That’s what President Obama believes, at least. He said so when he signed Dodd-Frank into law on July 21, 2010: Wall Street banks long had tricked Americans with fine-print traps, opaque investment pitches, and “abusive practices in the mortgage industry,” but Dodd-Frank would foster transparency and competition, and “make sure that everybody follows the same set of rules.” Wall Street banks had used the threat of systemic financial collapse to extort bailouts from the public, but Dodd-Frank would ensure that “the American people will never again be asked to foot the bill for Wall Street’s mistakes.” Above all else, there would be “no dividing line between Main Street and Wall Street. We rise or fall together as one nation” under Dodd-Frank.

So you can imagine the president’s frustration two years later, when he stood onstage at the first of three presidential debates and heard his opponent paint a very different picture. Said Mitt Romney:

Dodd-Frank was passed. And it includes within it a number of provisions that I think [have] some unintended consequences that are harmful to the economy. One is it designates a number of banks as too big to fail, and the

y’re effectively guaranteed by the federal government. This is the biggest kiss that’s been given to—to New York banks I’ve ever seen.

Romney was launching a direct assault not just

on Dodd-Frank, but also on the conventional wisdom that Dodd-Frank punished Wall Street.

If President Obama was frustrated by this sharp criticism of one of the administration’s landmark legislative achievements, he was not alone. The New Republic’s Alec MacGillis lambasted “the full chutzpah of Romney’s move,” “attempting to paint Obama as a crony of the biggest banks” despite bankers’ political contributions to Republicans. Elsewhere, Sheila Bair, former chairman of the

Federal Deposit Insurance Corporation, called Romney’s comments “misinformed.”

If Romney touched a nerve, it was not because he was contrarian, but because he was correct. As many analysts and officials have explained, Dodd-Frank subsidizes large, influential Wall Street financial institutions, while imposing disproportionately heavy burdens on Main Street banks and the communities they serve. Even if we take President Obama, Senator Dodd, Representative Frank, and the rest of Dodd-Frank’s supporters at face value when they protest that they actually intended to rein in Wall Street banks, the laws they passed accomplish the opposite result. Intentional or not, a kiss is still a kiss.

Governor Romney’s criticisms targeted the parts of Dodd-Frank that were ostensibly enacted to limit the power of too-big-to-fail financial institutions. Title I creates the Financial Stability Oversight Council, an interagency board that will formally designate certain large banks and nonbank financial companies as “systemically important financial institutions” (SIFIs). Title II creates the Orderly Liquidation Authority, by which the Treasury secretary and the FDIC are empowered to “liquidate” troubled SIFIs.

By granting federal bureaucrats open-ended power and insulating them against crucial checks and balances, these provisions present grave constitutional concerns, which are the subject of a federal lawsuit filed recently by private plaintiffs and three states. More significant for present purposes, Titles I and II exacerbate the very problem they were purported to solve: the dangerous power of financial institutions that are treated as too big to fail.

According to the Treasury secretary, who chairs the Financial Stability Oversight Council, the council will soon begin designating large financial institutions as “systemically important.” When it does, the council will be making official a status that before Dodd-Frank was strictly unofficial and conjectural.

Official SIFI status will be worth billions of dollars to the companies that receive it, as demonstrated by the ever-heightening mountain of research that has attempted to quantify its benefits. Before Dodd-Frank, a handful of big banks enjoyed unofficial too-big-to-fail status among investors, simply because of the banks’ disproportionate size—$100 billion in assets was a common benchmark. Because those banks were seen as enjoying the likely protection of government intervention to prevent their failure, investors saw the banks as less risky than their “small enough to fail” competitors. Accordingly, the big banks were able to attract investment capital at much lower cost.

That has amounted to an immense subsidy, worth “about $4 billion per year before the crisis, increasing to $60 billion during the crisis, topping $84 billion in 2008,” according to a recent paper by the World Bank’s Deniz Anginer and Syracuse University’s A. Joseph Warburton. Other studies, including one by the Bank of England, presented similar findings.

Instead of ending that subsidy to big banks, Dodd-Frank intensifies it in at least three ways. First, by officially designating SIFIs, Dodd-Frank eliminates any uncertainty as to whether a bank is actually considered too big to fail. Second, by lowering the asset threshold from $100 billion to $50 billion, it increases the number of likely SIFIs. And third, by including not just banks but also nonbank financial companies, Dodd-Frank further expands the universe of possible SIFIs.

President Obama, former FDIC director Bair, and -others suggest that these SIFI designations are something that financial companies will want to avoid, not obtain, because SIFIs will face stricter oversight by federal regulators. Dodd-Frank’s regulators will put SIFIs into “a penalty box,” said Bair: Big banks might “try to spin it like it’s a good thing” to receive the government’s SIFI designation, “but it’s a bad thing.”

Such predictions reflect the triumph of hope over experience. If unofficial too-big-to-fail status was worth billions before Dodd-Frank, then official SIFI status will be worth even more today. One management consulting firm, Deloitte, went so far as to predict that banks falling short of the $50 billion threshold “are likely to face a strategic decision”: Either forgo SIFI status or “aim to become SIFIs to take advantage of possible perceived funding and other advantages, from being seen as having implicit government guarantees from being too big to fail.”

The Washington Post was blunter in its assessment: “Get ready for Too-Big-to-Fail envy,” it warned readers last year.

To the extent that Dodd-Frank’s proponents ever acknowledge this problem, they tend to fall back on a second defense: that Dodd-Frank’s Title II ensures that troubled SIFIs will be “liquidated,” not rescued, and that “taxpayers shall bear no losses from the exercise of” that liquidation authority. President Obama pressed this point when he signed Dodd-Frank: “Because of this law, the American people will never again be asked to foot the bill for Wall Street’s mistakes. There will be no more tax-funded bailouts—period. If a large financial institution should ever fail, this reform gives us the ability to wind it down without endangering the broader economy.”

That is wishful thinking. Title II does not actually require the government to “wind down” a troubled SIFI. Under Dodd-Frank, “liquidation” can consist of the government keeping the company alive and restructuring it by use of an FDIC-created “bridge financial company.”

In fact, that is the approach endorsed by the FDIC’s acting chairman, Martin J. Gruenberg. The FDIC will not wind down troubled SIFIs, as President Obama promised; instead, as Gruenberg explained in a May 10 speech, the FDIC’s “most promising resolution strategy” will be to take the SIFI parent company into receivership, transfer its assets to a bridge company, operate its subsidiary banking units, and ultimately keep the SIFI alive—an outcome that, Gruenberg suggested, will not just “mitigate systemic consequences” but also “preserve the franchise value of the firm.”

And in that process, the FDIC will be able to exploit a section in Dodd-Frank that gives regulators extraordinary power to ignore the rules of bankruptcy and favor certain creditors over others. The transparency of normal bankruptcy is replaced with a black-box process that empowers regulators and favors the most influential stakeholders, including, most likely, other government-designated SIFIs.

In short, Dodd-Frank’s “liquidation” provisions will not actually end too big to fail—they will sustain it. Dodd-Frank has “ended” too big to fail only in the same sense that the 1928 Kellogg-Briand Pact “ended” war.

Nor can it truthfully be said that “taxpayers” will not fund the liquidation process. Under Dodd-Frank, the Treasury Department and FDIC can fund liquidations by imposing fees on financial institutions—fees that ultimately are passed through to the taxpayers and others who own the stock of those fee-paying companies or who are the companies’ customers.

Accordingly, the Dallas Federal Reserve Bank’s 2011 annual report concluded that “the pretense of toughness on [too big to fail] sounds the right note for the aftermath of the financial crisis,” but, “for all its bluster, Dodd-Frank leaves TBTF entrenched.” The Dallas Fed’s president, Richard Fisher, has issued similar indictments of Dodd-Frank in a number of speeches. So have three other sitting Federal Reserve Bank presidents, according to Bloomberg Businessweek’s report, “Big Banks: Now Even Too Bigger To Fail.”

Fisher and the other critical Fed presidents are joined by Anginer and Warburton, the aforementioned economists who studied the implicit subsidy afforded to big banks by SIFI status. “The passage of Dodd-Frank in July 2010 did not eliminate investors’ expectations of government support. In fact, expectations of support rose in 2010,” they write.

But perhaps the most damning criticism comes from Neil Barofsky, the Treasury Department’s former special inspector general in charge of oversight of TARP, in his new memoir, Bailout:

From the front-row seat that I enjoyed during my tenure at SIGTARP, Treasury was and continues to be an institution that has been captured by Wall Street’s core ideology. … The same political and procedural barriers make it similarly unlikely that a future administration will seriously challenge the structure—and therefore the power—of the largest banks. Dodd-Frank didn’t change the postcrisis status quo of too-big-to-fail banks; it cemented it.

If Wall Street SIFIs are the beneficiaries of Dodd-Frank’s Titles I and II, then small community banks—which will never be deemed too big to fail—are the -losers. Investors will be much less inclined to invest in small banks when they can invest with less risk in bigger banks enjoying government protection.

This point was made by none other than Fed chairman Ben Bernanke in a speech delivered while Dodd-Frank was still pending in Congress:

Having institutions that are too big to fail .  .  . creates competitive inequities that may prevent our most productive and innovative firms from prospering. In an environment of fair competition, smaller firms should have a chance to outperform larger companies.

Too-big-to-fail status is a “pernicious problem,” Bernanke stressed, “one of the greatest threats to the diversity and efficiency of our financial system.” Yet President Obama and Dodd-Frank’s other supporters made it the centerpiece of modern financial regulation.

In addition to the subsidies that big Wall Street firms will receive from “systemic importance” status, Dodd-Frank further subsidizes them by creating a regulatory environment that gives big banks inherent advantage over small banks. Those advantages harm small banks, local communities, and ultimately the economy at large.

Dodd-Frank’s Title X created the Consumer Financial Protection Bureau, an agency with unprecedented independence and an open-ended mandate to litigate or regulate against “unfair,” “deceptive,” and “abusive” lending practices. Led by Richard Cordray, a former Ohio attorney general appointed by President Obama without the Senate’s advice and consent, the CFPB is poised to impose heavy new regulatory burdens on consumer lenders.

Because the CFPB wields such power—not just to define and punish “unfair,” “deceptive,” and “abusive” practices, but also to administer many statutes long committed to other agencies’ jurisdiction—the CFPB is

capable of wreaking regulatory havoc in the consumer banking industry.

For that reason, even Elizabeth Warren, a leading advocate of the CFPB’s creation, urged that the agency define its new standards up front, through “nuanced regulations that account for product innovation.” It would be a mistake, she argued, to try to define the law on a case-by-case basis through enforcement actions, because “regulation of consumer credit markets is not amenable to ex post judicial review”; regulation-by-litigation, rather than through public rulemaking proposals, would be a tool “too blunt to provide a comprehensive regulatory response to unsafe consumer credit products.”

But so far, Cordray has largely eschewed Warren’s advice. In a hearing before a subcommittee of the House Oversight Committee in January, shortly after his appointment, he asserted that Dodd-Frank’s central term—“abusive”—would “have to be a fact and circumstances issue; it is not something we are likely to be able to define in the abstract.” By refusing to lend any meaningful content to the statute’s operative terms before actually bringing enforcement actions, Cordray’s CFPB injects dangerous uncertainty into the banking industry. Community banks’ ability to offer “character loans”—loans justified at least in part on the character of the borrower, rather than on strictly quantitative data—for example, may no longer be tenable when the banks can’t be certain that such loans won’t be deemed “abusive” and prosecuted as such after the fact.

Cordray only exacerbated that uncertainty when he announced, in a recent Senate hearing, that the CFPB might also effectively rewrite standards already prescribed by federal statutes. At a hearing before the Senate Financial Services Committee in September, Cordray indicated to chairman Richard Shelby that the CFPB believes Dodd-Frank gives it “exception authority” to waive statutes and impose the agency’s own new standards.

By writing new law through case-by-case enforcement, and by asserting “exception authority” to effectively re-write statutes, the CFPB is substantially increasing bankers’ compliance costs. The absence of clear, simple,

up-front rules will force banks to hire ever more lawyers and regulatory compliance officers to keep up with changing laws—an outcome that inherently favors big banks over smaller ones. “Bank of America can fill a skyscraper with attorneys to comply with all the rules and regulations, but a community bank can’t do that,” Iowa’s banking superintendent told USA Today last year. “I know some bankers that are probably just going to quit making mortgage loans. I mean, what’s the point?”

James Hamby, president of a locally owned Oklahoma bank, testified to such effects before the House Oversight Committee in July:

The calculus is fairly simple; more regulation means more resources devoted to regulatory compliance, and

the more resources we devote to regulatory compliance, the fewer resources we can dedicate to doing what banks do best—meeting the credit needs of our local communities. Every dollar spent on regulatory compliance means as many as 10 fewer dollars available for creditworthy borrowers. Less credit in turn means businesses can’t grow and create new jobs. As a result, local economies suffer, and the national economy suffers along with them.

Another community banker, Jim Purcell of the State National Bank in Big Spring, Texas, testified before another committee that Dodd-Frank would inevitably direct customers away from small community banks and toward the local branches of big banks. The CFPB’s new rule on international wire transfers, for example, requires banks to disclose information that small banks simply cannot know, such as the fees or exchange rates to be charged by the foreign bank on the other end of the wire; those disclosure requirements inherently favor big banks with international branches, because the same bank is on both ends of the wire.

Purcell quoted the blunt conclusion of the Office of the Comptroller of the Currency’s senior deputy for midsize and community banks: “Regardless of how well community banks adapt to Dodd-Frank Act reforms in the long-term, in the near- to medium-term these new requirements will raise costs and possibly reduce revenue for community institutions.” In the long run, the deputy added, banks will have to adjust by passing new regulatory costs along to customers, by focusing on “the least risky customers as a way to manage their regulatory costs,” or by simply “exit[ing] businesses where they find that associated regulatory costs are simply too high to sustain profitability.”

Another possibility is that smaller banks will merge, to spread the burden of regulatory compliance. The Washington Post warned of this in August, reporting that Dodd-Frank’s compliance costs are among the factors that will spur mergers among small and medium-sized banks in the near future.

As community banks have increasingly withdrawn from the mortgage business, their market share is being absorbed by big banks, at great cost to customers. In a speech last week, Bill Dudley, president of the New York Fed, warned that mortgage originations are increasingly concentrated among “a few key financial institutions,” and that the lack of competition was preventing low interest rates, spurred by the government’s purchase of mortgage-backed securities, from passing through to actual mortgage borrowers.

The Financial Times’s account of Dudley’s speech put the point more bluntly: While “tougher regulation [is] leading many banks to pull back from arranging mortgages,” both Wells Fargo and JPMorgan “reported record profits last week because of a surge in mortgage loans.” In turn, the big banks’ “failure to pass on low mortgage rates” means that “consumers have less money left in their pockets, and fewer people can afford to buy a house.”

As Mitt Romney might say, those inflated profits, and the underlying lack of competition in the mortgage business, are just another gift—another kiss—from the government to the big banks.

If President Obama, Barney Frank, and other Democrats are puzzled by the fact that Dodd-Frank’s new regulatory regime actually helps big banks instead of hurting them, then their puzzlement owes to an ignorance of well-established economic theories of regulatory capture and rent-seeking—problems recognized by Adam Smith more than two centuries ago, no less than by James Buchanan and other proponents of economic “public choice theory” today.

Perhaps even more surprising, their puzzlement reveals their ignorance of the Democratic party’s own intellectual heritage. A century ago, progressive icon Louis Brandeis opposed Theodore Roosevelt’s “New Nationalism” precisely because it was premised upon the regulators’ cooperative relationship with incumbent monopolies, to the detriment of smaller companies and the public at large. As Brandeis urged in a memorandum to Woodrow Wilson on the eve of the 1912 election, Roosevelt’s Progressive party did “not fear commercial power, however great, if only methods for regulation are provided.” Brandeis, on the other hand, believed “that no methods of regulation ever have been or can be devised to remove the menace inherent in private monopoly and overweening commercial power.” Some two decades later, Brandeis reiterated these beliefs when he joined the Supreme Court’s unanimus decision in striking down the National Industrial Recovery Act, an early New Deal statute premised on the need for cooperation between regulators and big business, rather than competition among businesses. To assume, as Dodd-Frank’s proponents often do, that regulation is necessarily the enemy of large corporations—and necessarily the friend of smaller competitors, let alone their customers—is to ignore not just the present, but the past as well.

Mitt Romney was right in that first debate: Dodd-Frank is a gift to big banks, a fact that would have been as obvious to Louis Brandeis a century ago as it is to Neil Barofsky and other whistleblowers today.

C. Boyden Gray was White House counsel under President George H. W. Bush. Adam J. White is a lawyer in Washington, D.C. The authors are co-counsel to private plaintiffs State National Bank of Big Spring, the Competitive Enterprise Institute, and the 60-Plus Association in the lawsuit challenging the constitutionality of parts of Dodd-Frank. They write here strictly on their own behalf.

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