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‘The Biggest Kiss’

Mitt Romney was right: Dodd-Frank is a gift to big banks

Oct 29, 2012, Vol. 18, No. 07 • By C. BOYDEN GRAY AND ADAM J. WHITE
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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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