President Trump’s executive order that establishes a framework for scaling back the 2010 Dodd-Frank financial overhaul law is an opening salvo intended to signal a sweeping plan to dismantle much of the regulatory system that was put in place after the financial crisis. This is something candidate Trump pledged during his campaign. But considering the legislative heavy lifting required to “repeal and replace” Obamacare, not to mention the headwinds Trump’s immigration ban has faced, is it realistic to expect repeal or reform to deal with Dodd-Frank anytime soon? And what effects on business are likely to result?
When the Dodd-Frank Wall Street Reform and Consumer Protection Act took effect on July 21, 2010, it immediately caused a sharp partisan division. This staggeringly large legislation—2,300 pages—passed the House without a single Republican vote and received only three GOP votes in the Senate. The law was intended to prevent another financial meltdown, but instead, as AEI scholar Peter Wallison wrote in a recent Wall Street Journal op-ed, Dodd-Frank “has overwhelmed the regulatory system, stifled the financial services industry and impaired economic growth.”
Dodd-Frank’s supporters claimed the regulation would help Main Street over Wall Street. Yet the number of community banks fell by 40 percent since 1994, and their share of U.S. banking assets fell by more than half—from 41 percent to 18 percent. In contrast, the biggest banks saw their share of assets rise from 18 percent to 46 percent. And while the number of community banks already declined before the crisis, since the second quarter of 2010 – Dodd-Frank’s passage – community banks have lost market share at a rate double what they did between Q2 2006 and Q2 2010: 12 percent vs. 6 percent.
Data analysis from the Federal Deposit Insurance Corporation demonstrates that relative to bigger banks, community banks service a disproportionate number of commercial bank loans in agriculture, residential mortgages, and small and mid-size business loans. As the number of community banks shrivels through consolidation and insolvency, Main Street borrowers are forced to apply with bigger institutions, only to face rejection or stiffer terms. Dodd-Frank financial regulations supposedly meant to help the little guy and curtail banking behemoths had the opposite effect. Numerous critics warned of this threat, which was confirmed by research undertaken by Marshall Luxe and Robert Greene from Harvard’s Kennedy School of Government.
The best example was illustrated several years ago when JPMorgan Chase announced plans to hire 3,000 more compliance officers to bring its compliance force total to 10,000. At the same time the bank reduced its overall headcount by 5,000. Substituting employees who produce no revenue for those who do is the legacy of Dodd-Frank, and it will be with us as long as this law is on the books.
However, business leaders at small and midsized firms need not wait for relief in the form of ‘repeal and replace’ legislation, which can take time and will entail another bruising battle in congress. “It is difficult to gauge what exactly will happen since the president’s executive order is general, but it sends a strong message,” says AEI’s Wallison. “One can interpret the order as an opening to do away with Dodd-Frank in the right way with specific legislation.”
But to the extent that Trump acts on financial regulatory policy—and much of what has retarded the financial community falls within such policy—bank regulators can be induced to back away from some of the more onerous regulations. If some of the regulatory costs can be rolled back allowing for more profits, credit for small and midsized companies can open up. “The law encouraged regulators to suppress risk-taking to the point that it also suppressed credit and liquidity, which in the end, retarded economic growth,” argues Wallison. “Never mind that the lack of regulation never caused the financial crisis in the first place.”
Wallison says that Jeb Hensarling, the Republican chair of the House Financial Services Committee, came up with the Choice Act last year to serve as a clean blueprint to deal with the problem. It would primarily allow banks to choose between complying with Dodd-Frank or meeting tougher capital requirements—primarily to maintain a ratio of tangible equity to leverage exposure of 10 percent. It also would reorganize the Consumer Financial Protection Bureau, throw out the Volcker Rule restricting banks from making speculative investments and eliminate the authority of the Financial Stability Oversight Council to designate non-banks as “systemically important.” It also differs from the Dodd-Frank legislation in the way it treats insolvent banks. Hensarling says his approach will prevent taxpayer dollars from being used to bail out failed institutions.
As Wallison testified before congress in 2015, large firms in the real economy, which can access the capital markets for financing, have been growing roughly in line with previous recoveries, but smaller firms that rely on banks for financing have grown far more slowly. Since most of the growth in the U.S. economy, and especially in employment, comes from small firms, the economy is underperforming, and will continue to underperform until the treatment of banks under Dodd-Frank Act is substantially modified or repealed.