Fixing Dodd-Frank Is Critical to Ending Bailouts

By Norbert Michel, Heritage Foundation financial regulations expert

Dodd-Frank is about to undergo a serious overhaul, and the first major part of the renovation is taking shape.

Chairman Jeb Hensarling’s (R-Texas) Financial Services Committee has scheduled its markup of the Financial CHOICE Act of 2017, the House’s major financial regulatory reform legislation, for Tuesday morning.

Based on the Committee’s hearing last week, there will be tons of fireworks on Tuesday, but little substantive debate from the Democrats.

The Democrats are treating Dodd-Frank as if it was divinely inspired. The truth, though, is that Dodd-Frank was passed before the Financial Crisis Inquiry Commission had even finished its report.

A charitable read of the climate from 2008 to 2010 is that key members of Congress were not sure what to do to address the financial system. Ranking Member Maxine Waters (D-Calif.) practically admitted as much last week when she questioned one of the Democrats’ witnesses. Waters said:

You were around when we went through the meltdown in 2008, and you know how scary it was, and we did not know what to do, we ended up with this bailout – should we go through that again? Do we have to go through that again? (1:03:24)

The many disparate pieces of the Dodd-Frank bill solidly support the first part of this statement – Congress clearly didn’t know what to do.

As for the question posed by Rep. Waters, nobody wants to go through a bailout again. That’s exactly why it’s so important to actually fix the problems that led to the 2008 meltdown. Given the turmoil between 2008 and 2010, it makes perfect sense to re-examine exactly what Dodd-Frank accomplished and fix any missteps.

It defies logic that Dodd-Frank got everything right, and a very good case exists that much of Dodd-Frank was the wrong approach. Here are a few candidates for the biggest Dodd-Frank mistake.

The Financial Stability Oversight Council (FSOC). The FSOC is a council of regulatory agencies with, among other things, an ill-defined mandate to stamp out risks to U.S. financial stability. It consists of 15 different federal regulators, but it includes only the chairpersons from agencies set up as bipartisan commissions, such as the Securities and Exchange Commission. There are many legitimate concerns over the lack of transparency and clear standards with respect to one of its main responsibilities: designating so-called systemically important financial institutions (SIFIs) for special regulations. Above all other concerns, if the goal is to end the too-big-to-fail problem, it makes little sense to charge federal regulators with publicly identifying those firms that they consider too big to fail.

Orderly Liquidation Authority (OLA). Title II of Dodd-Frank created the OLA, a new resolution process that keeps certain financial institutions from going through bankruptcy. Specifically, Title II gives the Federal Deposit Insurance Corporation (FDIC) the authority to seize a firm and “wind it down” in the name of maintaining financial stability. It is designed to allow a parent holding company’s operating subsidiaries to continue functioning, which means that creditors will know they have a federal backstop for their activities. The entire process would only take place after federal regulators certify that no viable private alternatives exist. If the goal is to end government support for failing firms, it makes little sense to pre-announce that this resolution option exists. The fact that the very idea behind a legal bankruptcy process is to give distressed firms a way to remain viable businesses makes OLA look even more misguided.

The Consumer Financial Protection Bureau (CFPB). Title X of Dodd-Frank created the CFPB on the false premise that a lack of consumer protection caused the financial crisis. (Even Rep. William Lacy Clay (D-Mo.) acknowledges that banks were subject to consumer protection prior to Dodd-Frank). To create the CFPB, Dodd-Frank transferred the authority for more than 20 federal consumer protection statutes to the new agency. It also introduced a new consumer protection concept, prohibiting abusive practices, without any clear definition or standards. This concept is highly flawed, and nobody has ever made the case for why prohibitions against unfair and deceptive practices – in place since the 1930s – aren’t enough to protect consumers from fraud. The CFPB is unaccountable to the public in any meaningful way, and its design raises serious due process and separation of powers concerns. A federal court has even ruled that the CFPB’s structure is unconstitutional. That fact alone suggests the CFPB was ill-conceived.

The Durbin Amendment. Section 1075 of Dodd-Frank, known as the Durbin Amendment, implemented price controls on the interchange-fees charged in debit-card transactions on the premise that banks and card networks had colluded to fix prices. The judicial branch, not Congress, is supposed to be the arbiter of such disputes. Congress created the antitrust legal framework decades ago, and it should never have jumped into this legal dispute as if it were the judicial branch. Regardless, experience clearly shows that price controls do more harm than good.

The Volcker Rule. Section 619 of Dodd–Frank, otherwise known as the Volcker Rule, was supposed to protect taxpayers by prohibiting banks from engaging in what is known as proprietary trading — that is, making risky investments solely for their own profit. Although it sounds logical to stop banks from making “risky bets” with federally insured deposits, banks actually make risky investments with federally insured deposits every time they make a loan. Furthermore, the recent financial crisis had nothing to do with banks’ trading activities. The practical difficulties associated with implementing the rule caused regulators to spend years working on what ended up being an enormously complex rule without any clear benefit.

Dodd-Frank was an 800-plus page bill that required regulators to develop more than 400 rules touching on virtually every aspect of financial markets. It cannot possibly have gotten everything right.

Unfortunately, many Democrats made it clear during last week’s hearing that they will not even entertain whether any part of Dodd-Frank was the wrong approach. They want nothing to do with the approach in the Financial CHOICE Act.

Oddly enough, that puts the Democrats in the same camp as some of the nation’s largest financial firms.

*Originally published in Forbes, click here.

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