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It’s the other repeal-and-replace bill: After a party-line vote, House Republicans have sent the Senate a bill that would reform the Dodd-Frank financial-regulation law, a cumbrous and ill-conceived piece of legislation that has hurt small banks and credit unions and is much in need of being revisited, even if the GOP bill, like its health-care bill, doesn’t amount to a full-on repeal. The Senate would do well to act on it but is unlikely to do so: Democrats are implacably hostile to reforming Dodd-Frank, and Republicans do not have the numbers to easily do so in the teeth of unified Democratic opposition.


Dodd-Frank, drawn up in the wake of the 2008–09 financial crisis, is a kind of financial PATRIOT Act: It was passed in response to an acute trauma, and, like much legislation of that sort, it is a dog’s breakfast of political and regulatory entrepreneurship. It does a great many things — it was the midwife of Elizabeth Warren’s beloved Consumer Financial Protection Bureau — but it does not address the causes of the financial crisis and the recession that followed.

The law imposes the Volcker Rule, which prohibits commercial banks (i.e., banks of the kind that take FDIC-insured consumer deposits) from engaging in certain kinds of “proprietary trading,” meaning trading their own funds for their own profit. It also restricts commercial banks’ investments in hedge funds and private-equity investments. Proprietary trading had nothing to do with the 2008–09 financial crisis, and if the Volcker Rule had been in place, it would have had no effect. It is a restriction on commercial banks, whereas the institutions at the center of the financial crisis were investment banks. But both commercial banks and investment banks are in the business of assuming financial risks — that is what lending money means — and neither the Volcker Rule nor any rule like it would prevent the root cause of the crisis: Banks made bad investments.


By limiting banks’ ability to make certain kinds of investments, the Volcker Rule may in fact leave the banking system less stable, because banks will have fewer opportunities to hedge the risks they acquire through their ordinary lending operations.

Likewise, the Consumer Financial Protection Bureau is a creature of progressive wish-fulfillment rather than a meaningful response to the financial crisis. It probably will have to be restructured or disbanded irrespective of what becomes of the rest of Dodd-Frank, in that its structure, which protects its director from ordinary democratic accountability, is probably unconstitutional — the D.C. Circuit Court of Appeals has ruled that it is. CFPB has a very open-ended portfolio and is by design an instrument of political harassment. It may not be the worst thing about Dodd-Frank, but it is malevolent enough.



The Republican alternative to Dodd-Frank, the Financial CHOICE Act, would do what Dodd-Frank did not do: It would help raise banks’ capital reserves, meaning that financial institutions would have more money on hand to offset large and unexpected losses, making the system more stable. (Banks’ capital cushions did go up after Dodd-Frank, but did so largely in response to other factors: the Basel III rules and a pronounced shift to lower-risk investments.) The Financial CHOICE Act would offer banks relief from onerous Dodd-Frank regulations in return for carrying larger capital reserves — larger insurance policies, in effect. It would also return the management of insolvent financial institutions back to where it belongs: bankruptcy court.

Since the passage of Dodd-Frank, U.S. banks have seen the number of regulations to which they are subject double in gross terms, with 28,000 new restrictions on their activities put into place. As often is the case, big companies are much better prepared to meet these regulatory requirements — and the big ones become even bigger as the high cost of regulation creates powerful incentives for consolidation. It is worth noting that thousands of smaller banks and credit unions have disappeared since the passage of Dodd-Frank, while those “too big to fail” institutions are even bigger than they were before the crisis.


Dodd-Frank does much that is counterproductive and does little to address the actual causes of the 2008–09 financial crisis. The Financial CHOICE Act represents a distinct improvement and deserves support.


READ MORE:

Elizabeth Warren’s Secrets and Lies

The Tragic Downfall of the Consumer Financial Protection Bureau​​​

Cordray’s Choice: To Save the CFPB, Its Director Must Resign