Treasury Report Good First Step towards Financial Reform

On Monday, the Department of the Treasury issued its first response to the President’s Executive Order 13772 on core principles for regulating the financial system. The first report covers regulation of banks and credit unions. While there is much to admire in the report, there is one recommendation that causes us great concern.

First, the good stuff. The report does not shy away from concluding that financial regulation has caused serious problems for the banking system. It notes, rightly, that the asset thresholds used to apply regulatory requirements (such as Dodd-Frank’s threshold of $10 billion in assets for applying stress tests) are “limiting competition against the largest institutions and, consequentially, may be contributing to the solidification of the market position of the largest institutions.” This is precisely what we mean when we talk about Dodd-Frank entrenching the problem of Too Big To Fail. The Treasury also notes that Dodd-Frank’s increased regulatory burden “has had a disproportionate Impact on the competitiveness and viability of community banks.” All in all, Treasury finds that,

The implementation of Dodd-Frank…created a new set of obstacles to the recovery by imposing a series of costly regulatory requirements on banks and credit unions, most of which were either unrelated to addressing problems leading up to the financial crisis or applied in an overly prescriptive or broad manner.

This is what CEI has been arguing would happen since Dodd-Frank was first proposed.

The report is particularly critical of what it terms “activities-based regulation,” and the way it has restricted consumer lending, particularly in areas like small dollar loans, mortgage lending, and indirect auto lending. The Consumer Financial Protection Bureau is viewed as particularly at fault here.

Among Treasury’s recommendations, the following are particularly noteworthy:

• Congress should take action to consolidate regulators so as to reduce overlap and duplication in the structure. Having to deal with similar but slightly different requirements from more than one regulator is a significant contribution to the excessive compliance costs of financial institutions.
• The Office of Financial Research, which suffers from many of the same constitutional problems as the CFPB, should become a part of the Treasury Department and get its funding from Congress to allow for oversight.
• Stress tests should be applied to banks when they have over $50 billion of assets rather than $10 billion. This would allow regional banks to grow and compete with Wall Street banks.
• Stress testing and capital planning review frameworks should be subject to notice-and-comment, which would allow for proper review of the many concerns about the meaningfulness of stress tests. Also, “living wills” would become a biennial rather than an annual exercise.
• The Treasury strongly recommends proper accountability and funding basis for the CFPB. While we at CEI would prefer to see the Bureau abolished, this restructuring would go a long way towards reining in this rogue agency. The Treasury also recommends “adopting reforms to ensure that regulated entities have adequate notice of CFPB interpretations of law before subjecting them to enforcement actions; and curbing abuses in investigations and enforcement actions.” Amen to that.
• Finally, the Treasury would significantly reform the Volcker Rule, which was always a solution in search of a problem, and hit Main Street banks, destroying jobs in the process.

In addition, the Treasury recommends giving relief to community banks and credit unions from the requirements of Basel III capital standards, critically examine the effects of Basel III in general, and use much more rigorous cost-benefit analysis in assessing the likely impact of rules. These are all good suggestions.

Where we express concern, however, is in Treasury’s recommendation for an expanded role for the Financial Stability Oversight Council (FSOC). CEI’s original complaint in its lawsuit over the constitutionality of certain provisions of Dodd-Frank singled out FSOC as unconstitutional. We noted,

[T]he FSOC’s formation and operation violates the Constitution’s separation of powers. The FSOC has sweeping and unprecedented discretion to choose which nonbank financial companies to designate as “systemically important” (or, “too big to fail”). That designation signals that the selected companies have the implicit backing of the federal government—and, accordingly, an unfair advantage over competitors in attracting scarce, fungible investment capital. Yet the FSOC’s sweeping powers and discretion are not limited by any meaningful statutory directives. And the FSOC, whose members include nonvoting state officials appointed by state regulators rather than the President, is insulated from meaningful judicial review—indeed, from all judicial review brought by third parties injured by an FSOC designation…Taken together, these provisions provide the FSOC virtually boundless discretion in making its highly consequential designations, a violation of the separation of powers.

Now it may be that Treasury’s forthcoming report on regulation of the asset management and insurance industries will recommend an end to that sweeping discretion, and/or that it might request Congressional action to provide meaningful statutory direction. Yet as long as FSOC decisions remain insulated from meaningful judicial review, our concern remains that it will have more power than any entity should have in our constitutional republic.

That said, we welcome many of the recommendations and look forward to the further three reports in the series.