After Five Years, Dodd-Frank Is a Failure

After Five Years, Dodd-Frank Is a Failure

The law has crushed small banks, restricted access to credit, and planted the seeds of financial instability.

Jeb Hensarling

July 19, 2015 5:50 p.m. ET  

 

Tuesday will mark five years since President Obama’s signing of the Dodd-Frank law, the most sweeping rewrite of the country’s financial laws since the New Deal. Mr. Obama told the country that the legislation would “lift our economy.” The statute itself declared that it would “end too big to fail” and “promote financial stability.”
None of that has come to pass. Too-big-to-fail institutions have not disappeared. Big banks are bigger, small banks are fewer, and the financial system is less stable. Meanwhile, the economy remains in the doldrums.
Dodd-Frank was based on the premise that the financial crisis was the result of deregulation. Yet George Mason University’s Mercatus Center reports that regulatory restrictions on financial services grew every year between 1999-2008. It wasn’t deregulation that caused the crisis, it was dumb regulation.
Among the dumbest were Washington’s affordable-housing mandates, beginning in 1977, that led to a loosening of underwriting standards and put people into homes they couldn’t afford. The Federal Reserve played its part in the 2008 financial crisis by keeping interest rates too low for too long, inflating the housing bubble. Washington not only failed to prevent the crisis, it led us into it.
Dodd-Frank was supposedly aimed at Wall Street, but it hit Main Street hard. Community financial institutions, which make the bulk of small business loans, are overwhelmed by the law’s complexity. Government figures indicate that the country is losing on average one community bank or credit union a day.
Before Dodd-Frank, 75% of banks offered free checking. Two years after it passed, only 39% did so—a trend various scholars have attributed to Dodd-Frank’s “Durbin amendment,” which imposed price controls on the fee paid by retailers when consumers use a debit card. Bank fees have also increased due to Dodd-Frank, leading to a rise of the unbanked and underbanked among low- and moderate-income Americans.
Has Dodd-Frank nevertheless made the financial system more secure? Many of the threats to financial stability identified in the latest report of Dodd-Frank’s Financial Stability Oversight Council are primarily the result of the law itself, along with other government policies.
Dodd-Frank’s Volcker rule banning proprietary trading by banks, and other postcrisis regulatory mandates, has drastically reduced liquidity for making markets in fixed-income assets. The corporate bond market is one of the primary channels for capital formation in the economy. Reduced liquidity in this market amplifies volatility. Because of Dodd-Frank, financial markets will have less capacity to deal with shocks and are more likely to seize up in a panic. Many economists believe this could be the source of the next financial crisis.
Dodd-Frank’s scheme for regulating derivatives markets concentrates systemic risks into clearinghouses and then designates the clearinghouses as too big to fail. Dodd-Frank’s “orderly liquidation authority” enshrines taxpayer-funded bailouts into law. Meanwhile, the Fed, by keeping interest rates too low for too long, is introducing dangerous imbalances into financial markets and is likely inflating asset bubbles.
What is most disturbing about Dodd-Frank is the authority it gives bureaucrats to control huge swaths of the economy. The director of the Consumer Financial Protection Bureau, an agency created by Dodd-Frank, can declare any consumer-credit product “unfair” or “abusive” and outlaw it. Oversight? CFPB funding is not subject to congressional appropriations, and Dodd-Frank requires courts to grant the bureau deference regarding its interpretation of federal consumer-financial law.
Dodd-Frank requires that bank holding companies worth $50 billion or more must submit a “living will” to the Federal Deposit Insurance Corp. and the Fed. This “will” is a detailed plan for how the company will cope in case of severe financial problems. If the plan is not to the regulators’ liking, they can require the company to restructure, raise capital, divest or downsize.
The “heightened prudential supervision” Dodd-Frank allows the Fed to exercise over “systemically important” banks essentially places them under government control. Soon the Fed may exercise effective control over the largest insurance companies and asset managers as well. After AIG and GE Capital were designated “systemically important,” Fed officials, according to a Financial Times story last August, became de facto board members of the firms, involving themselves in decisions including whether employees should be fired or disciplined.
Before Dodd-Frank’s passage, former Sen. Chris Dodd said that “no one will know until this is actually in place how it works.” Today we know. The law he co-wrote with former Rep. Barney Frank is gradually turning America’s largest financial institutions into functional utilities and taking the power to allocate capital—the lifeblood of the U.S. economy—away from the free market and delivering it to political actors in Washington.
Five years ago, House Republicans offered the Consumer Protection and Regulatory Enhancement Act as an alternative to Dodd-Frank. It sought to restore market discipline, end taxpayer bailouts and protect consumers with innovative, competitive markets policed for fraud and deception. It’s time to revisit the ideas in that bill, offer new ones and replace Dodd-Frank.
Mr. Hensarling, a Republican congressman from Texas, is chairman of the House Financial Services Committee.