President Trump on Friday signed executive orders postponing a contentious rule on investment advisors and another directing the Treasury Department to conduct a review of the Dodd-Frank Act, with the intention to generate proposals for reform. If we are to avoid or at least minimize the impact of future financial crises, then such a review is an imperative, as Dodd-Frank has failed to address the actual causes of the crisis, while in many areas leaving our financial system even more vulnerable.
Part of the public dissatisfaction that drove Trump into office is a direct result of Washington’s response to the financial crisis. While big banks, along with the auto companies, were rescued, middle-class Americans were left picking up the tab.
Rather than begin an earnest effort at ending bailouts, Washington tapped two of the architects of the hated bailouts, then-Senator Chris Dodd, D-Conn., and then-Rep. Barney Frank, D-Mass. Given both of their roles in delaying reform before the crisis and then helping to shovel public money to Wall Street, it should not have surprised anyone that the bill they produced allows for permanent bailouts. Even worse, it’s a bailout mechanism without even the modicum of accountability that comes with having Congress to vote on each bailout.
Trump promised to drain the swamp that is Washington. There is no better place to start than repealing Dodd-Frank’s bailout authority, found in its title II.
Treasury’s review should also propose the elimination of Dodd-Frank’s process of designating certain companies as “systemically important.” This sends a signal to the markets that these companies are “too big to fail,” undermining the monitoring of these companies by their creditors and other market participants. Let’s not forget it was this “too big to fail” status that allowed Fannie Mae and Freddie Mac to operate at massive levels of leverage that no private firm could ever attain.
House Financial Services Committee Chair Jeb Hensarling, R-Texas, is currently working on legislation to repeal the worst elements of Dodd-Frank while also improving the stability of our financial system. The heart of his proposal is an increase in bank capital. Despite liberal claims, Dodd-Frank has done very little to actually raise the amount of capital in our banking system. What improvement we have seen in capital has been a combination of changes to the Basel capital accords and banks shifting into assets which require less capital, like government debt and Fannie Mae securities.
Replacing both Dodd-Frank and Basel’s convoluted system of capital regulation with a simple, but higher leverage ratio would encourage bank lending to move away from funding the government towards funding the private sector.
This is one of the central reasons for the Obama economic recovery being one of the weakest in modern history. Reforms imposed under Obama have resulted in a massive shift of financial activity from productive activities, like job creation, to funding government transfers. Job creation, along with wage growth, greatly depends upon reforming our financial system.
Trump’s executive order on the Labor Department’s so-called “fiduciary rule” is also an important step in getting our economy on more stable grounds. A recurring theme in Dodd-Frank, as witnessed in the fiduciary rule, is a massive increase in legal uncertainty. The problem is not making sure that investors or consumers have their best interests protected, the problem is in having to run the risk that every minor error leaves financial service providers vulnerable to class action litigation.
When businesses can’t even calculate their litigation risk, they leave that market. We have already seen this in the mortgage market, where only the best credits can get a non-government backed mortgage.
We are almost a decade past the last financial crisis. Despite much scurrying around and endless amounts of paper produced, Washington has actually done little to avoid future bailouts and improve the stability of our financial system. Unfortunately, what has been done has come at great economic cost. We can have both a strong economy and a more stable financial system. Reforming Dodd-Frank is a critical step along that path.
Mark Calabria (@MarkCalabria) is a contributor to the Washington Examiner’s Beltway Confidential blog. He is the director of financial regulation studies at the Cato Institute. Previously, he was a senior staff member of the U.S. Senate Committee on Banking, Housing, and Urban Affairs.
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