Counterpoint: Dodd-Frank Act Does Not Make Us Safer
Editor’s Note: For an alternative viewpoint, please see: Point: Breaking Up the Big Banks Won’t Stop Another Financial Crisis
Half a decade after the 2010 Dodd-Frank Act became law, its proponents remain in denial. They confidently proclaim “big banks” are no longer a problem because the law eliminated dangers in the banking system.
Baupost's investment process involves "never-ending" gleaning of facts to help support investment ideas Seth Klarman writes in his end-of-year letter to investors. In the letter, a copy of which ValueWalk has been able to review, the value investor describes the Baupost Group's process to identify ideas and answer the most critical questions about its potential Read More
Former Rep. Barney Frank, D-Mass., co-author of the legislation, recently assured the New York Times that his signature legislation was “doing what it was designed to do.” All such talk is grossly off the mark.
First of all, decades of research have failed to conclusively isolate bank size as a risk factor behind bank failures and economic crises. It certainly didn’t cause the 2008 meltdown. Still, policymakers are debating whether it’s a good idea to “break up the big banks.”
This would be utter folly. Even Barney Frank recognizes that it requires an impossible task: identify “the right size” for banks.
Unfortunately, even the Dodd-Frank advocates who understand this bank-size problem fail to acknowledge that it also applies to the so-called risk management regulations in Dodd-Frank.
For example, Frank recently claimed his law was a success because, “We gave the regulators the authority to impose risk-retention requirements on all loan securitizations.” (His boast conveniently ignores the fact that private lenders used risk-retention requirements long before the 2008 crisis, without being directed to do so by law.)
Just as it is impossible to identify a bank size that is miraculously risk-free, so nobody can possibly know in advance what the “right” risk-retention requirements should be. No matter what the requirement, there’s still a risk of financial loss from an unforeseen source, on an unanticipated scale.
The Dodd-Frank legal standards do nothing to change that equation. At best, they provide a false sense of security.
There’s also no doubt that this framework increases the opportunities for regulators to work closely with the buyers and sellers of these securities, crafting rules that ultimately help various industry groups mitigate their losses. (The wonky term for this phenomenon is “regulatory capture.”)
Regardless, the regulators empowered with setting the new standards are the same ones that completely missed the 2008 crisis, so we probably shouldn’t feel too safe right now.
Another faulty claim is that Dodd-Frank forced banks to hold more capital. In reality, the 2010 law did not mandate the Basel III rules that guide federal capital standards for most banks. If Dodd-Frank were repealed today, bank capital requirements would barely change.
One exception is the leverage ratio found in Section 165 of Dodd-Frank. But that standard suffers from the same problem as all other legal capital requirements: even the regulators don’t know what the “right” standard is to mitigate future problems. They clearly messed up the risk-based capital system in place prior to Basel III.
Separately, federal regulators have been adjusting capital requirements for decades in response to crises. At best it’s been a high-stakes game of whack-a-mole.
Regardless, the data show that there hasn’t really been much of an increase in bank capital since Dodd-Frank. According to FDIC data, the ratio of capital to assets was 11.1 when Dodd-Frank was signed into law. By the end of 2015, it was up to 11.2.
That’s almost a new standard for unimpressive.
Others point out that Dodd-Frank gave us the Consumer Financial Protection Bureau, an agency that supposedly will protect us from “predatory lending.” What they mean by this is that the CFPB has barred banks from giving mortgages to unsuspecting dupes who can’t possibly repay their loans.
Again, the logic fails. No bank would ever consider adopting this so-called “predatory business plan” unless someone or something promises to make good on such bound-to-fail loans. That someone is the federal government.
For decades federal policies have pushed banks and mortgage companies to make more and more shoddy loans that could be sold to the government-sponsored enterprises Fannie Mae and Freddie Mac. The goal was to increase home ownership.
Even if other factors contributed to the 2008 crisis, it’s ludicrous to argue that this affordable housing scheme had nothing to do with the crash. Yet Dodd-Frank did nothing to address this problem.
Dodd-Frank Act is bad law because it increases regulators’ authority to micro-manage financial risks and further enshrines the so-called emergency measures (government loans, government guarantees, etc.) that the government employed during the 2008 crisis. These measures give creditors and capital suppliers less incentive to be careful.
The real tragedy here is that the federal government has steadily increased its interference in financial markets for decades.
Dodd-Frank was merely the next step in the big-government policy parade that produced the 2008 crisis.