Reforming bank reform

The head of the Dallas Fed:

Everyone and their sister knows that financial institutions deemed too big to fail were at the epicenter of the 2007–09 financial crisis. Previously thought of as islands of safety in a sea of risk, they became the enablers of a financial tsunami. Now that the storm has subsided, we submit that they are a key reason accommodative monetary policy and government policies have failed to adequately affect the economic recovery. Harvey Rosenblum and I first wrote about this in an article published in the Wall Street Journal in September 2009, “The Blob That Ate Monetary Policy.”[3] Put simply, sick banks don’t lend. Sick—seriously undercapitalized—megabanks stopped their lending and capital market activities during the crisis and economic recovery. They brought economic growth to a standstill and spread their sickness to the rest of the banking system.

Congress thought it would address the issue of TBTF through the Dodd–Frank Wall Street Reform and Consumer Protection Act. Preventing TBTF from ever occurring again is in the very preamble of the act. We contend that Dodd–Frank has not done enough to corral TBTF banks and that, on balance, the act has made things worse, not better. We submit that, in the short run, parts of Dodd–Frank have exacerbated weak economic growth by increasing regulatory uncertainty in key sectors of the U.S. economy. It has clearly benefited many lawyers and created new layers of bureaucracy. Despite its good intention, it has been counterproductive, working against solving the core problem it seeks to address…

Dodd–Frank comes against a background of ever-greater escalation of financial regulation. He points out that nationally chartered banks began to file the antecedents of “call reports” after the formation of the Office of the Comptroller of the Currency in 1863. The Federal Reserve Act of 1913 required state-chartered member banks to do the same, having them submitted to the Federal Reserve starting in 1917. They were short forms; in 1930, Haldane noted, these reports numbered 80 entries. “In 1986, [the ‘call reports’ submitted by bank holding companies] covered 547 columns in Excel, by 1999, 1,208 columns. By 2011 … 2,271 columns.” “Fortunately,” he adds wryly, “Excel had expanded sufficiently to capture the increase.”

Though this growingly complex reporting failed to prevent detection of the seeds of the debacle of 2007–09, Dodd–Frank has layered on copious amounts of new complexity. The legislation has 16 titles and runs 848 pages. It spawns litter upon litter of regulations: More than 8,800 pages of regulations have already been proposed, and the process is not yet done. In his speech, Haldane noted—conservatively, in my view—that a survey of the Federal Register showed that complying with these new rules would require 2,260,631 labor hours each year. He added: “Of course, the costs of this regulatory edifice would be considered small if they delivered even modest improvements to regulators’ ability to avert future crises.” He then goes on to argue the wick is not worth the candle. And he concludes: “Modern finance is complex, perhaps too complex. Regulation of modern finance is complex, almost certainly too complex. That configuration spells trouble. As you do not fight fire with fire, you do not fight complexity with complexity…

The approach of the Dallas Fed neither expands the reach of government nor further handicaps the 99.8 percent of community and regional banks. Nor does it fight complexity with complexity. It calls for reshaping TBTF banking institutions into smaller, less-complex institutions that are: economically viable; profitable; competitively able to attract financial capital and talent; and of a size, complexity and scope that allows both regulatory and market discipline to restrain excessive risk taking.

Our proposal is simple and easy to understand. It can be accomplished with minimal statutory modification and implemented with as little government intervention as possible. It calls first for rolling back the federal safety net to apply only to basic, traditional commercial banking. Second, it calls for clarifying, through simple, understandable disclosures, that the federal safety net applies only to the commercial bank and its customers and never ever to the customers of any other affiliated subsidiary or the holding company. The shadow banking activities of financial institutions must not receive taxpayer support.

Gretchen Morgenson at the NYT agrees. We do too.

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