The US financial system is safer and more stable than it was a decade ago in the depths of a financial crisis. And big banks are widely profitable.
All this because of – or some say despite – major bank legislation known as the Dodd-Frank Act.
So when the Senate, in a rare showing of bipartisan cooperation, passed a bill Wednesday to roll back portions of Dodd-Frank and to lighten the regulatory burden on community banks, it could have been just another ho-hum legislative revision and update. Instead, the bill drew fire from both the left and right and, as a result, may not pass Congress.
Many Democrats in Congress cast the move as a brazen capitulation to banks. Conservatives say the bill doesn't go far enough to deregulate the industry.
The reality, analysts say, is that this one bill by itself won’t gut the rule book for America’s financial system. The real risk, many say, is if this represents just one step – followed by others – down a slippery slope toward more lax oversight. That could ultimately endanger the health of the financial system on which the rest of the economy depends, from businesses to homeowners.
Banks “should be careful what they wish for,” says Aaron Klein, a Brookings Institution finance expert who, while serving in the Obama administration, helped write the Dodd Frank law. “Sometimes my kids ask me for a lot of candy and then get a stomachache.”
It's this fear that has many Democrats exercised.
“There’s a long history in Washington of members of both parties teaming up to deregulate banks – followed soon after by a financial crisis,” said Sen. Elizabeth Warren of Massachusetts on March 8, calling the new bill the #BankLobbyistAct.
Conservatives, like Rep. Jeb Hensarling (R) of Texas, are pushing for even more regulatory relief for banks, and saying their proposed changes would beat Dodd Frank at ensuring that future misdeeds of big banks don't result in bailouts or bring down the financial system.
In the House, Hensarling has proposed a so-called Financial CHOICE Act that, he as he put it last year, would promote “faster and healthier economic growth by replacing bailouts with bankruptcy, complexity with simplicity, and bureaucratic micromanagement with free market discipline.”
The two sides are clashing over an age-old thread-a-needle dilemma. On the one hand, banking rules should aim to minimize the risk of disastrous credit booms and busts, and that means not making banks feel bailouts are inevitable in a crisis. On the other hand, the overall economy needs some safeguards against collapse in such a crisis. (Remember TARP, the Troubled Asset Relief Program that Congress passed in a hurry as the economy tottered in 2008?)
No one has a perfect answer. Critics of the House Republicans say dramatically lightening bank regulation is unrealistic, while Mr. Hensarling says the existence of Dodd-Frank has pushed up bank fees on consumers while codifying the idea of bailouts.
The new Senate bill includes a host of provisions. Some of the biggest:
• Exempts smaller banks (less than $10 billion in assets) from certain global rules on the level of capital they must hold.
• Lightens “Volcker rule” limits on investment-trading activity for those same smaller commercial banks. Representative Hensarling would eliminate the Volcker rule for all banks.
• Raises the threshold for being regulated as a “systemically important” bank from $50 billion to $250 billion in total assets, and gives the Federal Reserve flexibility to tailor regulations for banks with assets between $100 billion and $250 billion.
On that last provision, Senator Warren says banks with $200 billion in assets are hardly the “community banks” that, she and others agree, deserve some regulatory relief. Mr. Klein says: “Financial stability is not necessarily hinging on this change,” although it does mean lighter regulation for some very large regional banks.
Not just for banks
The bill also includes a raft of new consumer protections (such as unlimited free credit freezes and unfreezes per year, an issue thrust into the spotlight by the data breach at credit-reporting firm Equifax). Critics say these efforts don’t go far enough.
And the legislation seeks to make it easier for small lenders to make mortgage loans. Critics warn that, in the process, important data-gathering for tracking racial discrimination would be reduced.
The bipartisan Senate support may reflect both the clout of the financial industry and the electoral vulnerability of purple- or red-state Democratic incumbents who don’t want the image of party-line liberals. It also reflects something that’s become rare on Capitol Hill: efforts by Banking Committee Chairman Mike Crapo (R) to include Democrats and follow “regular order” in crafting the bill.
Now the legislative action shifts to the House, where a bill can be passed on Republican votes alone. If Hensarling and his colleagues try more aggressive deregulation, it could imperil the chances of any Senate-House compromise being reached. That's because the Senate leadership needs Democrats to pass a filibuster-proof bill, and the latter are unlikely to back more deregulation.
So, even if new legislation ultimately passes, it appears that core elements of Dodd-Frank will remain, including heightened oversight of the largest banks, and requirements for those systemically important banks to have “living wills” to prepare them for possible liquidation should they fail.
In the end, Klein says that, as important as the details of law are, another key is the tone set by front-line regulators, those at agencies like the Treasury and Federal Reserve tasked with monitoring compliance and potential emerging risks. For now, everyone from Congress to Trump administration officials and banks themselves is pushing generally in the direction of a lighter touch.
“The legal framework can be strong, but if the regulators don't act, the system can run into significant problems,” Klein says.