Not Dodd-Frank, Not Glass-Steagall, But Real Competition to End TBTF

Progressives cheered Hillary Clinton last week when she said policy makers need to “go beyond Dodd-Frank.” She didn’t rule out repeal of some sections, but most took it to mean preserve virtually all of the law—which turns five on July 21—plus expand government intervention further into banking.

But that praise was short-lived when Clinton’s economic adviser Alan Blinder told Reuters, “You’re not going to see Glass-Steagall” reinstated in her administration. The New Deal-era Glass-Steagall Act separated commercial and investment banking until it was partially repealed by the Gramm-Leach Bliley Act, which passed Congress overwhelmingly in 1999 and was signed into law by Clinton’s husband, President Bill Clinton.

There seems to be a bipartisan chorus for Glass-Steagall restoration, from Clinton’s self-proclaimed socialist rival Bernie Sanders to conservative GOP candidate Ben Carson. These politicians tap into a frustration on the left and right that on the fifth anniversary of the so-called Dodd-Frank “financial reform,” too-big-too-fail banks are more entrenched than ever.

In my new paper for the Competitive Enterprise Institute, I note that this frustration is well-grounded. “Today the banking industry is more concentrated than ever,” I write. But I and plenty of others have noted that much of the reason is Dodd-Frank itself, plus the effects of regulation put into place and signed into law by GOP Presidents George W. Bush, Richard M. Nixon, and Dwight D. Eisenhower. To really tackle too-big-to-fail and end bank bailouts for good, I argue, we need to lift these barriers to real competition in banking.

“In the financial industry, as in any other industry, greater competition can help bring stability, innovation, and choice,” I write. It’s easy to forget that when it comes to bailouts, the financial industry is largely unique. There was virtually no call in recent years to bail out Blockbuster Video, Borders, Eastman Kodak, and, most recently, Radio Shack, even though their bankruptcies cost thousands of jobs and wiped out shareholders

Why? The short answer is that unlike with bank failures, no consumers were threatened with shortages in supply in these other industries, thanks in large part to new entrants. Blockbuster’s customers could stream Netflix or rent their movies from Redbox. Borders customer could order their books from Amazon.

Yet both before the financial crisis and after, there has been a dearth of new entrants in banking. In fact, since 2010, only one new bank has received federal regulators’ permission to open—the Bird-in-Hand Bank in the Amish country of Pennsylvania.

So what will bring the dynamism of competition into the banking sector? It will not be more restrictive rules that limit what banks can do, even if they are targeted at “big banks.” We’ve seen that with Dodd-Frank’s “Volcker Rule,” also called “Glass-Steagall lite.” The Volcker Rule bans “proprietary trading,” which is banks trading with their own money rather than that customers, and was sold by proponents as only reining in big Wall Street casino banks.

Yet days after the rule went into effect, the first victim was a respected regional bank that couldn’t be further away from Wall Street: Zions Bank of Salt Lake City, Utah. The rule forced Zions to divest a long-held debt security and take a loss of $387 million, an amount greater than what the bank had earned in any calendar year since 2007. For more on the horrors of the Volcker Rule, read this sharp new post by Meghan Milloy of the American Action Forum.

Bringing back Glass-Steagall itself would likely have similar perverse effects on small and regional banks. As I have written, many regional and community banks hit by the mortgage crisis have rebounded in part through wealth management, which runs the gamut from investments to insurance. But banks would be restricted from entering into these areas for their customers if Glass-Steagall were to return. Glass-Steagall also had virtually nothing to do with the players involved in spreading the crisis, which were government-sponsored enterprises such as Fannie Mae and Freddie Mac and pure investment banks such as Bear Stearns and Lehman Brothers that did not take deposits.

To really tackle too-big-too-fail, policymakers need to focus on easing barriers to new entrants in the banking sector. In addition to Dodd-Frank, regulations have created a de facto moratorium to new banks. For instance, a specific FDIC policy put in place around 2010 requires “de novo” or new bank applicants to put up 8 percent of the assets they project to have in seven years. This helps explain why there has been only one successful new bank applicant in the past five years.

And laws and policies of the Bush, Nixon, and Eisenhower administrations have prevented the best-run American corporations from entering the banking sector. Warren Buffett’s Berkshire Hathaway, for instance, was forced to sell off in 1980 an Illinois bank it had run successfully for a decade. It was then thwarted from acquiring another bank related to its retail subsidiary RC Willey in 1985. Walmart has also been thwarted by U.S. regulators from acquiring a banking subsidiary, even though it has owned successful banks in Canada and Mexico.

As I conclude in the paper: “It is time to bring what the great economist Joseph Schumpeter called ‘creative destruction’ to the banking industry, by bringing in the competition from new entrants that exists in every other industry. There’s no banks like new banks!”

For more on Dodd-Frank’s five-year trail of destruction—from Durbin Amendment price controls on what banks may charge retailers to process debit cards that have sent checking account fees soaring  to the requirement that manufacturers disclose their use of “conflict minerals” from the Congo—read the recent congressional testimony of CEI Chairman and George Mason University Law Professor Todd Zywicki.