The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), which will turn 5 on July 21, is the sweeping regulatory response to the financial crisis and Great Recession. Recent news reports paint a picture of an assault on Dodd-Frank, whether in the guise of trade agreements or legislation being drafted by Senate Banking Committee Chairman Richard Shelby.
Consider first the amendment to the Senate Trade Promotion Authority bill proposed by Senator Elizabeth Warren. In its entirety it reads:
FOR AGREEMENTS THAT UNDERMINE THE FINANCIAL STABILITY OF THE UNITED STATES.--
The trade authorities procedures shall not apply to an implementing bill submitted with respect to a trade agreement or trade agreements entered into under section 103(b) if such an agreement or agreements include provisions relating to financial services regulation.
Of course, it is silly to think that any president would negotiate an agreement to "undermine the financial stability of the United States." Putting that aside, it also repeats one of the most common misnomers about trade agreements. Trade agreements are an opportunity to enhance the standards of trading partners; not degrade domestic standards.
When the North American Free Trade Agreement (NAFTA) was signed by the U.S., Canada, and Mexico in 1994 there were claims it would lead to a "race to the bottom" in environmental regulations. There is no evidence of any such race.
Any claim of undermining Dodd-Frank in either the Trans-Pacific Partnership or the Transatlantic Trade and Investment Partnership are similarly baseless. In particular, the U.S. could use TTIP to entice Europe to match U.S. capital and liquidity standards and adopt its approach to cross border resolution.
Put simply, the amendment interferes with an opportunity for the U.S. to export the very Dodd-Frank reforms that the Senator so strongly favors.
The concerns - including hyperventilating by my former Financial Crisis Inquiry Commission colleague - over the Shelby legislation are similarly misplaced. The Shelby bill contains lots of small tweaks and technical corrections, many of which are nearly five years overdue. But at its heart are three main objectives.
The first is to reduce the regulatory burden on community banks, credit unions, and other smaller entities that are being force to spend their scarce dollars on hiring more compliance officials and cutting back on lending and customer service. With only 114 finalized rules (less than one-half of the needed regulations) Dodd-Frank has already proven to be a costly behemoth - a cost that is exacerbated by additional requirements stemming from the Basel accords. The total compliance burden is already $21 billion and it has imposed 62 million additional hours of compliance paperwork.
The financial crisis did not emanate from the small banks that are the lifeblood of Main Street commerce. It is a cost without benefit to subject them to the full burden of the Dodd-Frank regime. For example, the Shelby bill exempts banks with less than $10 billion in assets from the Volcker rule. The regulations on proprietary trading are among the most costly of the rules with which to comply and there is no evidence that proprietary trading - even at the largest banks - was at the root of the crisis.
The second broad thrust is codifying the many improvements in the processes surrounding designating non-bank entities as "SIFIs" - systemically important financial institutions. Specifically, the Financial Stability Oversight Council (FSOC) is required to provide a nonbank financial company with:
- Information about why FSOC is considering it for designation at stages in the designation process;
- Meetings with FSOC or its representatives, a hearing on its status, and the guaranteed ability to submit materials to FSOC (including a plan of changes to avoid SIFI status);
- FSOC's analysis of any such remedial plan and the chance to revise the plan; and
- An explanation of any FSOC decision to designate.
The Shelby bill also provides an important "off-ramp" from SIFI status. Each year the firm would have the ability to meet with the FSOC, propose a plan to make it safe enough to avoid SIFI status, and get a vote by FSOC on the plan. Also, every five years the designation would lapse and FSOC would have to re-examine and re-designate the non-bank institution as a SIFI.
The net effect of the Shelby legislation would be to guarantee all firms equal treatment by the FSOC, some transparency into the designation process, and guarantee that SIFI status is not the financial Hotel California. Hardly revolutionary stuff.
The last major initiative is to take a more nuanced approach to the designation of bank holding companies (BHCs) as "SIFIs" - systemically important financial institutions. For banks with more than $500 billion in assets, nothing changes. However, for those between $50 billion and $500 billion the Shelby bill discards a one-size-fits-all approach for a series of reviews by the Federal Reserve and the Financial Stability Oversight Council (FSOC).
Specifically, the Fed can recommend that the FSOC take a look at a BHC (or the FSOC can just do it). At that juncture, the bill lays out a straightforward set of steps for designation that mirror the process for nonbank financial entities.
Dodd-Frank is a sweeping regulatory initiative and there is no reason to believe that Congress got it right the first time around. It did not. But it is equally unrealistic to equate any small attempt to improve it as a wholesale assault on the desirable goal of avoiding a future financial crisis.