Proof that Democrats were right about the Dodd-Frank Act: the law is working as intended.
Proof that Republicans were right about the Dodd-Frank Act: the law is not working as intended.
Unfortunately, both of those statements are correct at the same time, which means we have some delicate work in front of us to reform the Dodd-Frank Act this summer. All those confident Congress can manage such task, please raise your hand.
Yep, I’m sitting on my hands too.
Two business stories this week capture the Dodd-Frank dichotomy. First in the Wall Street Journal was news of General Electric putting the assets of its commercial lending operation up for sale. This is the part of Dodd-Frank that’s working. A financial business as large as GE Capital might pose systemic risks to the financial system, and in 2013 regulators deemed GE a systemically important financial institution. GE doesn’t want to assume the compliance obligations that go along with that risky work, so it is selling off its finance and lending operations to escape SIFI status. The buyer is likely to be some large bank or financial firm more comfortable with this line of business.
Second is an article in the Financial Times about who owns the majority of government-backed mortgages these days. For the first time ever, the big players in this end of the mortgage business are non-bank financial firms. That’s because traditional banks are tired of the extra regulations imposed on them by Dodd-Frank, and retreating from the home loan business. Non-bank firms are filling the vacuum—which is awkward, since these firms are not subject to Dodd-Frank because they are not banks. This is the part of the law that isn’t working.
Let’s all remember the Dodd-Frank Act’s fundamental goal: to bring more stability to the financial system and end the need for taxpayer bailouts in times of stress. Yes, lawmakers larded the law with all manner of language irrelevant to that goal. And no, they did not address the fundamental problem, which is the oversized role that Fannie Mae and Freddie Mac played in the mortgage market before the 2008 financial crisis and continue to play today.
But from the average citizen’s perspective—and occasionally we should keep that person in mind—the goals of Dodd-Frank were straightforward: Don’t let financial firms get so large and entrenched with our banking system that if they crash, they bring the whole system down unless the taxpayer bails them out. It’s not a complex concept.
To that end, then, GE is behaving in an entirely predictable and even desirable way. GE Capital was the country’s seventh-largest financial firm when federal regulators gave General Electric SIFI status two years ago. You can’t be one of the largest financial firms in the United States and not be systemically important. If you don’t like it, you can change your strategy and operations to scale back your importance—especially if finance is not your core business, and for GE it is not.
I have no illusions that shedding all these operations is easy, or even something GE really wants to do, since the profits from GE Capital have been lucrative. But most taxpayers would be far happier to live with diminished returns from GE stock in their retirement plans than risk enduring another 2008 financial crisis again.
Which brings us to the non-banks creeping into the mortgage market, and all the cynics poised to tell me that if I believe pruning the size of SIFIs inoculates us from another crisis, I’m delusional.
The cynics are right. All we have done so far is apply regulatory pressure on one part of the financial sector (traditional banks and their mortgage business) and then watch that risk resurface in another, less regulated area. I could cite several other examples of new, oversized risks, from swollen student loan debt that won’t be repaid in full, to rock-bottom interest rates fueling an overheated stock market. Don’t even get me started on the systemic risks in other nations that we can’t govern at all.
We have let the politically popular objective of Dodd-Frank—avoid taxpayer bailouts of the banking sector—eclipse the much more important, and difficult, objective: curb systemic risk in the financial sector. We’ve taken the blunt instrument of higher capital reserve requirements and used it against the much more nuanced problem of managing different types of risk. So the cynics are correct to call Dodd-Frank enforcement a game of financial Whac-A-Mole. It is.
Personally, I would like to see Congress revive the idea of a systemic risk regulator, one of the many good ideas from 2009 that never survived into the final legislation from 2010. The hackneyed version that survived, the Financial Stability Oversight Council, is that usual product of Washington: all meetings, no clarity. Republicans who keep blaming Fannie Mae and Freddie Mac are also right on that point, although they lack any real idea of how to support the mortgage business without them.
We probably will not see much useful reform of the Dodd-Frank Act this summer, despite all the hearings and hot air currently hovering over the Capitol. But the one thing we should not be while observing the current regulatory landscape is surprised.
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