President Donald Trump wants to dismantle much of the Dodd-Frank Act of 2010, which was designed to prevent another financial crisis. The law barred banks from many profitable but risky businesses, forced them to add loss-absorbing capital, and required them to make detailed plans for how to shut down in a crisis. Critics say it made banks wary of lending by overburdening them with rules, hampering the economic recovery. Bloomberg View columnists Tyler Cowen and Noah Smith met online to debate Trump’s proposal.
Smith: Dodd-Frank is an incredibly complex, multifaceted piece of legislation. So it’s almost certain that many of its provisions will turn out to have been unnecessary. I think it’s always good to revisit these reform bills years later, after political pressure to “do something” has subsided, and fix the parts that don’t work.
That said, what I see as the core elements of Dodd-Frank seem important. The various provisions for orderly liquidation of bankrupt financial companies seem like something we’ll need down the road. Bringing derivatives from over-the-counter to exchanges also clearly seems like a good thing. The Consumer Financial Protection Bureau seems important as well. These are all approaches that have worked well elsewhere. We already have Federal Deposit Insurance Corp. liquidation of banks, exchanges for stocks and futures, and consumer protection for foods and beverages.
What do you see as the key elements of Dodd-Frank that need to be repealed or deeply changed?
Cowen: The most significant part of Dodd-Frank has been higher capital requirements, which have made banks put more “skin in the game” and also protected the taxpayers. But after that, I am mostly skeptical.
It seems Dodd-Frank has lowered bank-charter values, and thus pushed them closer to insolvency. It also seems likely that Dodd-Frank has made mortgage lending more expensive, thereby slowing the economic recovery and also poisoning the political climate. Those are some pretty significant costs.
As for the rest, we mostly don’t know. For instance, bringing derivatives into exchanges, one of the examples you mention, might be putting too much pressure on clearinghouses and creating a new class of too-big-to-fail institutions.
Too many aspects of this bill don’t have strong evidence behind them. Dodd-Frank is a classic example of “We must do something. This is something. Therefore we must do it.”
Smith: When evaluating the impact of Dodd-Frank, I’d be very careful of post hoc, ergo propter hoc reasoning. Houses tend to be burned-out wrecks after fire fighters leave them; this doesn't mean we want to lay off all the fire fighters.
When the crisis hit, many people realized the existence of risks that they had ignored before. The realization of those risks should make mortgage lenders a lot more cautious, regulation or no regulation. In any case, I wouldn’t worry about mortgages too much -- 30-year rates are near historic lows.
I am concerned about Dodd-Frank’s impact on bank business models. But it’s also possible those models just didn’t make sense anymore by 2007 without excessive leverage. Bond markets have taken over most business lending in the U.S., leaving banks reliant on mortgage lending and trading. Increased capital requirements, which you and I both support, might make those business models into a sunset industry.
As for derivative exchanges becoming too big to fail, I don’t understand this argument. Is the Chicago Mercantile Exchange too big to fail? Or the New York Stock Exchange?
Cowen: I think your fire analogy is a good one. Buying fire insurance makes sense, but it is possible to buy too much of it, or to buy it at the wrong time. With Dodd-Frank, we bought a lot of crisis insurance, but did so right after all the major bubbles popped. A whole generation of investors avoided excess risk-taking, as reflected by the crowding into Treasury securities. So we didn’t need more crisis insurance at that point in time.
In other words, with Dodd-Frank we gave up some economic growth and probably received very little or nothing in return. It would have made more sense to pass a financial reform bill 10 or 15 years out, when perhaps a new crisis would be brewing, not in 2010.
The big clearinghouses are probably too big to fail, and Dodd-Frank boosted the size of some new clearinghouses, such as ICE Clear Credit. I’m agnostic on this development. But I find it striking how much Dodd-Frank advocates, who are mostly suspicious of the big banks, are happy to endorse putting more governmental faith in a clearinghouse controlled by those same big banks. Upon examination, the arguments for most of the individual parts of Dodd-Frank just aren’t that strong.
Smith: I agree that Dodd-Frank, like most big post-crisis regulatory pushes (Sarbanes-Oxley being another example), is closing the stable door after the horse has bolted. But there’s another important factor here: politics. The immediate aftermath of a crisis might well be the only time that political will can be mustered for needed reforms. Those regulations might not be needed immediately, but could be very helpful a decade or two down the line.
Actually, without appealing to arguments based on political will and timing, it’s very hard to justify an immediate repeal of Dodd-Frank. Instead, I think it would make more sense to wait and look at the evidence about how each piece is affecting business. Some provisions will look bad, and those can be repealed or amended one by one.
There’s another issue to keep in mind here. A blanket repeal would have a good chance of being reversed under the next Democratic administration. Banks know this, and so will be reluctant to reestablish the business models forbidden by Dodd-Frank. Carefully considered, piecemeal amendment of the law, however, would leave banks much more confident that what is allowed today would be allowed in five years.
And I still don’t understand how an exchange can fail. The companies that own exchanges (for example, CME Group Inc.) do borrow small amounts, and could conceivably go bankrupt, but it seems like the operation of the exchange would just be taken over by another company, and trading wouldn’t halt.
Cowen: I’m not so happy about a policy that has a decade or two of costs and slower growth, and no associated benefits for a long time. If that is the best government can do for us, perhaps we should all be a bit more libertarian.
I agree we shouldn’t get rid of all of Dodd-Frank, and perhaps we would agree that the Trump administration might be erratic in replacing it, and this is to be feared. Still, without evidence for concrete benefits -- which in most cases I think isn’t there -- I would repeal a great number of the individual parts.
In the meantime, I am going to call it “overrated.”