In possibly her last visit as Chairwoman to the Federal Reserve’s annual conference in Jackson Hole, Wyo., Janet Yellen decided to go out with a bang. Rather than the customary focus on monetary policy, she used her platform to ardently defend the regulatory response to the 2007-2008 financial crisis. Foremost was her avowal that the Dodd-Frank Act has boosted resilience without damaging the economy, cautioning that any attempted reforms to the legislation should be “modest.”
Predictably, critics have piled on to criticize Republican efforts to peel back the post-crisis regulatory web, particularly through the Financial CHOICE Act. But they shouldn’t be so quick to. The CHOICE Act is a modest, common-sense reform that rolls back many of the worst provisions of Dodd-Frank while increasing the safety and soundness of the financial system.
Despite Yellen’s claim, the response to financial crisis has widely overshot the mark. Dodd-Frank has punished thousands of small institutions that did nothing to cause the crisis, while entrenching the power of largest banks—which it was designed to rein in. The Financial CHOICE Act laudably addresses both problems.
Since the enactment of Dodd-Frank, the United States has lost more than one in five banks, at a rate of nearly one per business day. The sheer weight of the regulatory burden has taken the greatest toll on community banks. Big banks, with armies of lawyers and compliance officers, can absorb the enormous costs that come with the increased regulation. But smaller banks simply cannot, forcing them to either merge with larger institutions or close.
It is hard to see how killing off one fifth of the banking system has made the economy more resilient. Furthermore, Dodd-Frank has consolidated the power of Wall Street. The big banks are even bigger than they were pre-crisis, with five banks holding nearly half of the industry’s assets, in part due to these regulatory induced mergers. Fortunately, the Financial CHOICE Act offers reforms that can increase competition.
Instead of imposing burdensome one-size-fits-all regulations on banks, as Dodd-Frank does, the CHOICE Act provides a regulatory off-ramp for banks that hold enough capital to buffer a down market. This is a common sense measure that allows banks to choose between higher capital standards or higher regulation and to tailor their business models accordingly.
The CHOICE Act also addresses the “too big to fail” problem, which Dodd-Frank has made worse through its systemically important financial institution (SIFI) designation. Through this designation, the Financial Stability Oversight Council can label many of the largest banks as “too big to fail.” While this is meant to subject SIFI banks to increased regulation, it enshrines government bailouts and subsidizes bank’s risk taking. The CHOICE Act narrows regulators’ SIFI designation authority and requires them to be more accountable and transparent.
It also establishes a new chapter in the bankruptcy code that provides a much more orderly process for liquidating a bank. This brings the focus back to safely winding down banks as opposed to propping up failing ones.
Research has suggested that Dodd-Frank has reduced post-crisis growth by 1 percent, with record low levels of business startups, investment, and jobs. It is no coincidence that this has been the slowest economic recovery in modern American history.
There is ample low-hanging fruit to pick in reforming the financial system. The Financial CHOICE Act resolves many of these issues effectively, removing the worst parts of Dodd-Frank while maintaining financial stability.
The CHOICE Act also includes a host of reforms that provide relief to community banks from unnecessarily burdensome regulations that have nearly killed off the industry. Yellen herself, as well as many top officials, have backed similar measures to ease the burden on small banks.
The Financial CHOICE Act is not the boogeyman its critics make it out to be. If anything, it is too “modest.” Republican efforts could have gone much further in reforming the financial sector.
This would include repealing the Durbin Amendment, a last-minute addition to Dodd-Frank that caps the fees on debit cards. This amendment has halved the rate of free checking and forced a million people out of the banking system. They could also reform the massive government-sponsored enterprises, Fannie Mae and Freddie Mac, which were among the leading culprits of the financial crisis.
For now, however, the Financial CHOICE Act offers a reasonable, common sense reform that eases the most pernicious impacts of post-financial crisis regulation, while ensuring greater safety and soundness. If Chairwoman Yellen is honest about the impacts of Dodd-Frank and open to such modest reforms, she should be supportive of the CHOICE Act.
Originally published to RealClear Markets.