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Dodd-Frank, a Non-Issue

The first presidential debate went over a lot of topics – taxes, Medicare, budgets – that were very much worth spending a lot of time on.  But one of the things that came up far more than I ever thought possible was the Dodd-Frank Act, aka the Wall Street Reform and Consumer Protection Act of 2010.  Mitt Romney called it “the biggest kiss to New York banks I’ve ever seen.”  He went on at some length about it, too, claiming “We need to get rid of that provision because it’s killing regional and small banks.”

Some of you know far more about this than I do, but this absolutely shocked me.  Dodd-Frank is really a non-issue, a half-step where a bold march forward is called for.  About half the world thinks it went too far and half thinks it didn’t go far enough, meaning it’s a rough compromise.  And, in practice, it doesn’t seem to have really changed very much.

How did this come up as an issue?  Dunno.  But I’m asking all of you to correct me if I have this wrong.

Dodd-Frank was passed in 2010 when the Democrats controlled both houses.  It’s named for Sen Christopher Dodd (CT) and Rep Barney Frank (MA) who sponsored the bill.  There are many sections to full of a laundry list of smaller provisions that provided more of a roadmap to regulation than any kind of complete overhaul.

It created the Financial Stability Oversight Council, which as its name suggests oversees (overlooks?) the general health of the financial industry as a whole.  New powers were given to the FDIC and Comptroller’s office to force big banks to conduct “stress tests” and required to have orderly liquidation plans.  It created a fund that will bail out “too big to fail” banks according to their plans, and regulates that they can’t have more than 3% of their investments in hedge funds.  Lastly, it overhauls the mortgage industry, imposes some tougher standards, and affords some consumer protection.

There’s a lot more to it than this, but you get the picture.  If I missed something important please let me know.  Yes, it touches nearly every aspect of banking in some way or the other – but it didn’t really change anything substantially.

The current rail against Dodd-Frank has to do with the way “too big to fail” was essentially codified into law, giving big banks an edge on lower interest rates (since they have lower risk) versus small banks.  The problem with this argument is that nothing really changed – the TARP of 2008 informed the market what would be done to save big institutions, “moral hazard” be damned.  Writing this into law was more about the responsibilities and new regulations that come into play for those banks than anything.

Which brings us to the claim that small banks are suffering.  It’s simply not true, as smaller banks are generally enjoying profits above and beyond what they saw in the 1990s and 2000s.  They seem to be where the action is these days, lending money to smaller entrepreneurs and businesses that have been turned down by larger banks.  They are probably the source of a lot of economic growth, especially in jobs, that has been hard to track.

So what’s the beef with Dodd-Frank?  To be honest, I have no idea.  If I ran a big bank like, say, JP Morgan, I might carp about the new regulation no end – which Jamie Dimon has done.  But for small banks, there does not seem to be much change at all in terms of how they do business.  Empirical evidence suggests they might be better off, but it would make more sense to chalk that up to the reality that small community banks are much closer to the action and much better at managing risk in today’s world.  This excellent analysis by Stephen Gandel of Fortune says it all.

The most reasonable thing that can be said about Dodd-Frank is that it’s not much of an issue.

Now, there may be something I’ve missed here.  Please, if there is, call me out on this.  But I can’t believe it even came up in a presidential debate in the first place.  The worst excesses of the mortgage industry have been called out, and everyone has to keep an eye on the worst case scenario in case it all fails one day.  What is wrong with that?  What, for that matter, has really changed in the way banks make money loaning it out and managing risk day by day?

16 thoughts on “Dodd-Frank, a Non-Issue

  1. I think you are mostly right. It does not seem to have mattered at all to small banks so that claim was just out of the blue.
    I have not had to deal with Dodd-Frank directly, but know many people that do. They complain about all the extra paperwork that they have as part of an audit trail that has to be done for every new loan. But I don’t know anyone who has said that it’s not necessary or even a good idea, they complain about the extra work.
    I think everyone in the industry has realized there are going to be new standards and we all hope they are relatively easy to comply with. Most are about codifying best practices as defined by professional organizations like NARA-MU. There has been a lot of leadership from these associations and I think that the regulators in charge of implementing Dodd-Frank have been listening.
    Any new regulation will be a pain but that does not mean it should not be done. There may also be a better way to implement it too. That is all to be expected and the fact that Dodd-Frank went in without a lot of problems shows that it is not an issue, no.

    • Sorry, but the link does not work. Want to try again?
      You are right, Glass-Steagall is what is needed. I’ve called for that separation between commercial and investment banking to become a global standard as a way of putting up a few walls to contain problems around the world.
      But there is so much more needed to modernize banking and make a much stronger connection to reality on the part of big banks.

  2. Sorry about the typo.

    Btw it’s Sen. Christopher Dodd and his biggest support came from insurance giants & financial institutions so I always found him disingenuously compromised. CT is the #1 state headquartering insurance companies.

    • Correction made (what a dumb mistake!). And yes, I agree with you on him. He’s not going to do anything his big supporters hate. To hear Romney carp about this half-measure with few real consequences says a lot about who his masters are, IMHO.

  3. That’s mean to say that Governor Romney has masters.

    In the debate Romney said a shortcoming of Dodd Frank is that it requires banks to provide only qualified mortgages, without defining qualified mortgages. Capital requirements for banks are increased, but banks can still sell loans to Fannie and Freddie, which require less capital.

    • They all have masters, you know it, too. 🙂
      As for defining terms precisely in law, that rarely happens. It was deliberately left up to the regulators, a normal procedure. And that has been refined since the passage of the law.
      As for Fannie and Freddie, I’m starting to side with Republicans that they are such a problem that getting rid of them may not be a bad option. A serious overhaul is at least worth talking about, if that is possible. Right now, they are indeed a “dumping ground” for sub-par mortgages, which can have a purpose but it is clearly being abused, IMHO.

  4. Okay, so they all have masters.

    Prior to the housing crisis, it was understood that even a dog could get a mortgage. We all know repayment of a loans displays a probability distribution. I think we have to ask why the dog and the bank were interested in developing a financial relationship. We have discussed moral hazard at length in Barataria. Unfortunately federal government exists to some extent to guarantee myriad types of loans and to be a lender of last resort. It is just the nature of the beast.

    I don’t see what good it does to mandate only qualified loans and then to penalize banks when they find out it is in default.

    • OK, that’s valid. I’ll have to think about it. There is a place for subprime mortgages and other loans, no doubt, but it’s all about appropriate assessment and labeling of risk. The bubble was all about just throwing that out the window. What’s a better way? Canadians often note that their home ownership is about the same as ours without any government programs and no interest deduction, which is a fascinating point. Is it possible that our attempts to goose the system only add complexity without advancing toward the goal?
      I’ll think about the rest. I’m starting to get a bit Republican on government loan guarantees generally, hoping to rely on regulation – especially regulation that revolves around assessment and labeling. That may not be enough or even reasonable.

  5. The size of a home downpayment and a applicant’s FICO score, I think, should be good predictors of ability to repay a loan. The FICO score is a well developed indicator and whole sectors of the housing finance industry knew they were giving loans to people with impaired credit. I think it would be good public policy to develop a consensus FICO credit score below which you do not qualify for a home loan. The reality is that a segment of the American population are not responsible credit users.

  6. I would support a ban on adjustable rate mortgages, if research and evaluation shows that it was a part of abusive lending practices.
    When the economy went south, many homeowners could not refinance, causing the foreclosures, the glut of unsold re possessed houses, and the deleveraging by banks. Some of the people with ARMs were young peoples, couples who had just gotten married, moved to a new city or who wanted to move out of an apartment. They looked forward to a bright future, but they lost their jobs.

  7. Pingback: With a Moslem Beat? | Barataria – The work of Erik Hare

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