Some Quick First Steps to Get Financial Reform Moving

The Dodd-Frank Act, signed into law under President Obama, was the most far-reaching change in American banking regulation since the creation of the FDIC and deposit insurance. Supporters of a strong hand in bank regulation frequently cite strong bank profits as evidence that Dodd-Frank and its related growth regulatory costs didn’t overreach. The core problem is that high bank profits have not translated into lending and growth the way they should in a normal economic recovery.

While the prospects of major banking law reform in the Congress appear dim, the banking regulatory agencies themselves have an opportunity to reduce the administrative burdens that derive from Dodd-Frank.

What follows is a roadmap for the initial work of incoming Trump administration nominees to the Federal Reserve, FDIC, and other banking regulators to quickly alleviate overreach in Dodd-Frank through reforms to two major and costly rules under that law. This roadmap utilizes discretion granted to the regulators by the Dodd-Frank Act itself.

The Federal Reserve should begin by rethinking the Dodd-Frank Durbin Amendment’s price controls on debit card fees. Price controls lead to undersupply, and in this context, the price controls on debit card fees have been associated with a reduction in free checking accounts. Furthermore, the price controls have not been passed through to consumers as supporters of the law initially predicted.

While the statute requires a price control, the Federal Reserve could substantially lift the ceiling on the price control as long as it can demonstrate the price cap it selects is “reasonable.” Among the ways it could demonstrate a reasonable increase could be the series of data breaches in the seven years since Dodd-Frank was adopted. That should suggest to any reasonable person that the financial services industry could use more revenue from debit card fees to guard against cybersecurity risks to consumers who use debit cards.

Another Dodd-Frank mandate that has made banks less safe is the Volcker rule’s restriction on proprietary trading. The idea behind the rule is that securities trading is riskier than banks’ more traditional practice of making loans secured by real estate. That idea is fundamentally flawed, particularly when viewed in the context of the last crisis. 

The flaws in this rule are compounded as five separate agencies have been charged with enforcing it, and in interpreting the thousand-page byzantine rule that implemented it. A Volcker interagency working group was established to help coordinate the joint enforcement. Agency personnel serving in that group report that discussions have evolved to little more than turf wars in which agencies tend to ignore each other. Market participants subject to review by multiple regulators for Volcker rule compliance are left to navigate conflicting positions from their own regulators with little guidance.

A small step toward rationalizing this regulation would be for each agency to enter into a memorandum of understanding providing for mutual recognition of their interpretations. If any one agency interprets a particular practice as allowed, the other four would be bound by the MOU to also accept it.

Over the longer term, until Congress is able to reconsider the wisdom of the Volcker rule in legislation, the five regulators should undertake a substantial simplification of the rule. In the 1980s and 1990s, the federal banking regulators had to interpret similar restrictions on trading, and opted for a much simpler definition: that trading more than a particular threshold of firm revenues — for example, more than 25 percent — would be prohibited. A similar approach to Volcker could establish a safe harbor for firms to feel secure that bank regulators won’t second guess otherwise legitimate hedging and market making activity.

The Volcker rule allows the regulators to expand existing exemptions to protect the financial stability of the United States. A recent study by the Federal Reserve itself finds that the Volcker Rule has led to a dramatic reduction in liquidity in the corporate bond market, risking market shocks in the future. This evidence supports a simpler safe harbor approach, designed as a percentage of revenue definition, to preserve the financial stability of the United States.

It has taken an extended period of time for the terms of the prior administration’s appointees to run out, and for the new administrations to select new appointees and get them through Senate confirmation. In early 2018, these appointees will finally have full control however of the banking regulatory apparatus.

While banks and American consumers await a statutory fix to the problems caused by Dodd-Frank, the regulators have been granted sufficient power by Dodd-Frank itself to begin to address its harm. The Durbin amendment and Volcker rule would be a good start.