Dodd-Frank's Birthday Marred By Its Many Inadequacies

Financial reform debates rarely dwell long on the purposes financial markets serve. Instead policy debaters move quickly from cursory diagnoses to regulatory remedies. As a consequence, the reforms that these discussions produce often inadvertently impede the proper functioning of the markets. An impaired financial industry can have deep and devastating effects on people far away from Wall Street and Washington.

The financial industry exists to serve consumers and companies that need to manage their risks and finance homes, educations, retirements, production, and innovation. The regulatory framework within which the financial industry operates can affect the industry's ability to effectively meet those needs. Many people simply assume that, on balance, more regulation will make financial markets function better. For example, 60 percent of the respondents in a Better Markets poll from earlier this month want "stricter regulation on the way banks and other financial institutions conduct their business."

The poll results might have been different if the respondents had also seen a June 2014 Goldman Sachs study that asks the important question-"Who Pays for Bank Regulation?" The research found that post-crisis financial regulatory efforts are particularly costly for low-income consumers and small businesses. A subset of consumers who were once able to get credit cards and home mortgages now rely on payday lenders, government agencies, and other nonbanks for credit.

Other consumers and small businesses still have access to bank credit, but they pay more than they did before. The Goldman Sachs study estimates that a household earning $50,000-the median annual income-pays an extra $200 a year in interest. With respect to business borrowers, the study estimates that small and mid-sized companies are paying, respectively, 41 and 55 basis points more on bank loans than they did pre-crisis. Larger companies, by contrast, are actually paying less than they did before the crisis to fund themselves.

The study attributes the disparate effects in part to the degree to which nonbank alternative sources of funding are available to different groups of consumers and businesses. As the study authors explain, "consumers and businesses that have ready access to alternative sources of finance are less likely to pay the incremental tax that regulation imposes." Low-income consumers and small businesses don't have many funding options, so they cannot avoid the regulatory tax.

There are a number of steps that regulators can take to preserve and expand funding options for consumers and small businesses. First, the capital markets, which the Securities and Exchange Commission regulates, can be a valuable alternative to bank financing for small businesses. The SEC, using its discretionary authority and the authority granted to it under the JOBS Act, can undertake serious efforts to open up viable funding sources for new and growing businesses. These efforts will fall flat, however, if new capital-raising avenues such as crowdfunding and Regulation A offerings are loaded down with costly obligations that put them out of the reach of small companies.

Second, bank regulators can look for creative ways to limit regulatory obligations on small banks. Dodd-Frank's burdens take a tremendous toll on these banks, which are key to small business lending. A well-capitalized community bank should not have to worry about being second-guessed by a bank examiner for making a loan to a local small business or a consumer with whom the bank has had a long-standing relationship.

Third, the Bureau of Consumer Financial Protection should not lose sight of its statutory objective to ensure that "markets for consumer products and services operate transparently and efficiently to facilitate access and innovation." The Bureau points to its rules, enforcement actions, and consumer complaint database as evidence of its solidarity with consumers, but it has not given sufficient thought to the potential effects of its actions on consumer prices and the willingness of companies to serve consumers. As Robert Clarke and Todd Zywicki wrote in a recent article, "Competition and consumer choice can be powerful vehicles for improving consumer welfare and consumer protection." The Bureau should embrace-rather than tolerate or ignore-its legal obligations to consider the effects its rules will have on small banks and other small businesses.

Fourth, regulators should look back at old regulations to identify those that are particularly harmful to small businesses and consumers. Bank regulators are currently conducting the 10-year review of regulations "to identify outdated, unnecessary, or unduly burdensome requirements" required under the Economic Growth and Regulatory Paperwork Reduction Act of 1996. This process provides regulators a key opportunity to consider whether particular rules or sets of rules are increasing the costs of consumers and small businesses to financing and decreasing their access.

Dodd-Frank's fourth birthday party was marred by talk of its long list of inadequacies. It is unfortunate to have to add the statute's regressive effects to that list. But regulators can do a lot before the law's next birthday to remove uneconomic regulatory impediments to the financial industry's ability to serve the full range of consumers and businesses.