Congress Needs to Fix America’s Broken Financial System

Whole forests have been cut down to print the books written about the financial crisis of 2007/8 and America’s response to it. Far fewer have been written on what’s wrong with the financial system now. Yet there’s a lot wrong with it. Despite historically low interest rates, banks aren’t lending to businesses or individuals, smaller and community banks have had to close or merge, low-income customers have seen free checking accounts disappear and their fees rise. The financial system is dysfunctional and not fit for purpose.

Most of the blame for this can be laid directly at the feet of the Dodd-Frank Act, passed in 2010 supposedly to stop another financial crisis happening by reining in the big banks with regulatory compliance. Yet the effect of the law has been to strengthen the position of the Wall Street banks most at fault for the crisis, while punishing the Main Street banks who behaved responsibly (there are more details on how this came about in my 2015 paper, “How Dodd-Frank Harms Main Street”).

In addition, the Dodd-Frank law also created a powerful regulator with all the conditions necessary for it to go rogue, which it did quickly – the Consumer Financial Protection Bureau. The CFPB was created with a powerful director who did not serve at the pleasure of the President, independence from Congressional oversight via funding, and with many of its decisions protected from judicial review. The Bureau’s exercise of the enormous power granted to it over the financial system finally led to a court case, PHH Corp. v CFPB, which found the Bureau not only to have acted outrageously towards the plaintiffs, but to have been structured unconstitutionally.

Congress needs to fix this system before another financial crisis hits. CEI’s scholars outline their suggestions for doing this in chapter 2 of our new Agenda for Congress. Our recommendations are:

  • Congress should pass the Financial CHOICE Act, in whole or in part, to fix the system by, for instance:
    • Allowing banks to swap a higher capital buffer for burdensome regulatory compliance
    • Make regulators accountable by reforming the Federal Reserve, CFPB, and other agencies
    • Provide a better resolution to the “Too Big to Fail” (TBTF) problem by replacing the counterproductive “orderly liquidation authority” of Dodd-Frank with a new chapter of the bankruptcy code.
  • Make the CFPB accountable. While the PHH case, if upheld, would make the CFPB Director directly responsible to the President, Congress needs to assert the power of the purse over the Bureau by making its funding part of the appropriations process.
  • Pass a series of reforms preventing regulatory overreach in financial services. These include
    • Protecting federalism by making sure that loans issued in one state cannot be considered usurious by another state.
    • Create a system of optional federal charters for nonbank finance companies that would allow them to export interest rates to out-of-state consumers.
    • Reforming the laws that enabled the Department of Justice to persecute financial companies whose activities they disapproved of in Operation Choke Point
    • Repeal the Durbin Amendment that capped fees related to debit card use, which resulted in banks increasing other fees without the consumer getting any benefit in reduced store prices.
  • Pass laws protecting innovation in financial technology – fintech. These laws would allow firms to seek more investment through crowdfunding platforms, allow more people to qualify as “accredited investors” who can invest in a wide range of enterprises, stop the Securities and Exchange Commission from regulating peer-to-peer loans as if they were securities, and protect digital currencies from overregulation.
  • Finally fix the TBTF problem by restricting the power of the Financial Stability Oversight Council, phase out Fannie Mae and Freddie Mac, phase out federal deposit insurance, and restrict regulators’ power to stop new banks from forming without adequate reason.

With these reforms, Congress will take the financial system off forced life support and allow it to start breathing freely again. The reforms will help unleash financial innovation and provide much-needed access to capital for businesses and individuals.