Reforming Dodd-Frank, for Real
Three months after taking office, President Trump promised to “do a number” on Dodd-Frank, the 2010 financial-regulation law championed by his predecessor. “These regulations enshrine ‘too big to fail,’” Trump said, rightly. Yet the bill that the Senate passed last week, with bipartisan support—the Economic Growth, Regulatory Relief, and Consumer Protection Act—is not so much reform as it is polishing the shrine. The bill would, in the short term, encourage mid-size banks to make more loans, possibly helping the economy. But the overall message— that too big to fail is here to say—outweighs that positive aspect.
Dodd-Frank had many flaws, the biggest of which was its overriding doctrine that certain banks and other firms are “systemically important financial institutions,” or “Sifis.” Thus, Dodd-Frank held, the government should do everything in its power to keep these institutions from ever having to declare bankruptcy in federal court—the common way for companies in a free market to restructure or liquidate themselves. To that end, Dodd-Frank mandated that any bank with more than $50 billion in assets be subject to special government stewardship via the new Financial Stability Oversight Council. Made up of top officials from the Treasury, the Federal Reserve, and the Securities and Exchange Commission, the council requires these banks to undergo regular “stress tests” to see what kind of event might cause them to fail, forces them to hold higher cash cushions to shield themselves from losses, and requires them to prepare “living wills” to see how they might wind themselves down if disaster strikes.
That all sounds like onerous government regulation, but a “Sifi” designation is really just another guarantee that a bank is “too big to fail.” If a Sifi were to fail, after all, it would be partly the government’s fault: all those extra regulators and government-designed exercises in assessing and reducing risk would have fallen short. The government should not be in the business of calling some companies “important”; the designation sends the wrong signal to markets. A single financial firm should be no more important to the economy than, say, Toys ‘R’ Us, or the National Steel Corporation, or Pan Am, all of which have gone bankrupt.
Rather than acknowledging and overhauling this fatal error, though, the Senate is only tinkering with the designation. The bill’s most important provision would increase the threshold at which a bank becomes “systemically important” from $50 billion to $250 billion. In isolation, this change is useful; it will ease the regulatory burden on 26 mid-size banks, letting them invest money that would otherwise be spent on compliance on making loans to customers. But, in exempting these banks from “sifi” regulation, Congress will signal that the nine banks left at the very top are really important, and that their survival is a matter of national interest that overrides free markets.
If Trump were to sign a version of the Senate bill, he’d be making it that much harder for any smaller bank ever to mount a challenge to the primacy of the nine firms at the top. A bank with $200 billion in assets seeking to buy a bank with $50 billion in assets, for example, would immediately face a bigger regulatory burden, in becoming a “sifi” under the proposed higher threshold. But it would still compete with banks just below the threshold, which would operate without such a burden, even as it continued to struggle to compete with the real giants in its new category.
Before Congress sends any proposed reform to Trump’s desk, it should revisit the ideas in a competing House bill passed last year, which would make far more progress on restoring free-market discipline to the financial sector. The House bill would treat all firms more equally, allowing for greater free-market competition, and would let financial firms choose whether to be regulated under Dodd-Frank. Banks could exempt themselves by opting to hold even higher capital cushions against losses. This approach isn’t perfect, either: if a law is flawed, it is better to fix it than to give companies the option of ignoring it. But at least the House bill is fair across the board; as its literature notes, it would apply to “financial institutions of all shapes and sizes,” thus not benefiting or penalizing an organization based on size.
Congressional negotiators will spend the next few weeks, or months, working on a uniform version of a bill to send to the president. Congress has made a good start in acknowledging that Dodd-Frank has had unintended consequences, particularly in terms of the regulatory burden imposed on mid-size banks. Yet declaring those banks to be systemically unimportant doesn’t solve the problem but rather entrenches it. Ending “too big to fail” won’t be done with a legislative decree altering just how big is too big.
