The Republicans’ banking bill is alright. Here’s a better idea.
A TSUNAMI hit the wonk world earlier this year, in the form of a bill loosening certain rules on certain banks. Last month, President Trump signed the bill into law.
The bill, as per usual, bears a horrific title: the Economic Growth, Regulatory Relief, and Consumer Protection Act. It’s almost as despicable as another recent prison reform bill titled the Formerly Incarcerated Reenter Society Transformed Safely Transitioning Every Person Act, which abbreviates to F.I.R.S.T. S.T.E.P. I think that acronym is Conditionally Restricting Access to Palatability, or C.R.A.P. (Funny enough, the guy who wrote the banking bill is named Mike Crapo.)
Anyway, back to the banking bill. But first, two sentences of context. No more than two—I promise.
After the 2008 financial crisis, Obama and a Congress chock-full of Democrats passed the 2010 Dodd-Frank financial regulation act, which did three main things. First, it tightened rules on the housing industry; second, it created the “Volcker rule” preventing a type of speculative investment; and third, it instituted new oversight on banks.
(See? That wasn’t so bad.)
The recent bill—written by Republicans, signed by Trump, and abetted by several Democrats—touches all three pillars of Dodd-Frank, but mostly the last one. After the financial crisis, regulators realized that if a bank was big enough, it was essentially “too big to fail.” That’s because a large bank failing could decimate the economy, creating an unignorable incentive to bail it out.
So Dodd-Frank created a legal framework by which to regulate too-big-to-fail banks. It deemed banks with more than $50 billion in assets S.I.F.I.s (short for “systemically important financial institutions”; another one of those acronyms). A S.I.F.I. is subject to added scrutiny from the Federal Reserve, which oversees banks.
The scrutiny is quite scrupulous, too. Banks are subject to “stress tests,” testing a bank’s balance sheets against a hypothetical crisis, and “living wills,” requiring each bank to prewrite a plan for its disassembly were it to fail. This sort of regulation doesn’t come cheap. It costs banks tens of millions of dollars each year to comply—even if for a compelling reason.
The banking bill raises the threshold for a bank to be considered a S.I.F.I. from $50 billion to $250 billion. Seems like a straightforward deregulatory move. But looking a tad closer, the banking bill actually creates three different tiers of banks.
Banks up to $100 billion in assets are fully exempted from S.I.F.I.-related oversight, meaning that the bill is a boon for banks with assets between $50 and $100 billion. That’s one tier. Banks with over $250 billion in assets will continue to be regulated as S.I.F.I.s. That’s another tier.
But the most interesting tier is the middle one. Banks with assets between $100 and $250 billion will be regulated at the discretion of the Fed. They are subject to stress tests, but not on a recurring basis. Also, the Fed is now legally obligated to tailor regulations to each of the 26 banks in the $100-to-$250 billion range. So at a basic level, the banking bill changes the regulatory treatment of midsize banks from consistent to discretionary.
This doesn’t seem like a great idea. The best kind of regulation is simple, predictable, and consistently applied. The banking bill will now create a regulatory environment for 26 banks which is potentially complex, unpredictable, and inconsistent.
What’s more, Matt Yglesias at Vox points out that the Republicans’ banking bill fits into a pattern of the Trump administration and its friends slowly chipping away at crisis-era regulations. He and other liberal voices reasonably suggest that such deregulation exposes the U.S. economy to another financial crash. Yet Mr. Yglesias overlooks the real need for Dodd-Frank simplification. There is a balance to be struck here.
Any Dodd-Frank reform bill like this one must be weighed against the downsides of Dodd-Frank—namely, its sprawling, highly prescriptive nature. Owing to its complexity, the law imposed $36 billion in compliance costs on banks between 2010 and 2016.
It’s reasonable to exempt smaller banks, defined loosely as banks under $100 billion in assets, from a labyrinth of federal rules, especially the aforementioned “Volcker rule” (as the banking bill does). These smaller community banks provide credit to credit-starved communities, promoting financial inclusion and economic development. Conversely, big banks should be diligently overseen. They are deeply woven into the world economy—doing otherwise would be reckless. On those two counts, the banking bill heads in the right direction.
The hard question is on midsize banks, which are as hard to define as they are to regulate. They are too big to responsibly exempt from oversight, but too small to absorb the stiff costs of intense, regular scrutiny. Over-regulating midsize banks is, in effect, a subsidy to big banks, which are far more easily able to bear the compliance costs of strict rules.
So here’s an idea: exempt banks with less than $25 billion in assets from Dodd-Frank regulations, subject banks over $250 billion to stress tests, and create G.D.P.-indexed capital requirements for all banks above $25 billion. Did your eyes glaze over at that last bit? Let me explain.
“Capital requirements” are rules that force banks to keep a certain percentage of their overall assets in their own on-hand cash (or “capital”). This means that the more “leverage” (i.e., borrowed money) the banks take on, the more of their own cash they are required to hold on to. So a highly leveraged bank must maintain a thick cash buffer, lessening the chance that a market shock leads to an economic crash.
Capital requirements should be indexed to G.D.P. so that banks are encouraged to build up their capital buffer in good times. The flip side is that capital requirements would be gradually eased were the economy to take a hit, providing banks more flexibility during the crunch.
Free marketeers love the flexibility which even stringent capital requirements (say, a 15% capital-to-assets ratio) afford banks. They are free to invest how they wish—so long as adequate capital is kept. Those inclined to favor a greater role for government should also favor higher capital requirements, which work better than prescriptive regulation in building cash buffers which enhance stability.
The banking bill doesn’t commit any heinous sins; it does more good than harm. But the Republicans passed up an opportunity to shore up financial stability while also paring back regulatory clutter. That would have easily been a win for the G.O.P. With the midterms looming, they really could’ve used one.
