Though they’re both under Republican control, the houses of Congress are operating on two different wavelengths. While the Senate Banking, Housing and Urban Affairs Committee convened a hearing this week with Wells Fargo CEO John Stumpf to question the firm’s massive consumer fraud, the House Financial Services Committee marked up and passed out of the committee a 513-page deregulatory bill (the Financial CHOICE Act) that bundles together a number of anti-reform proposals from the industry’s “wish list.” These include staples such as repealing the Volcker Rule and Durbin Amendment and changing the governance structure of the Consumer Financial Protection Bureau (CFPB) from a single director to a commission. (NOTE: This is the agency that recently fined Wells Fargo $100 million for the aforementioned widespread illegal activity, which involved employees creating fake customer accounts.)
The good news is the CHOICE Act isn’t going anywhere soon; it’s unlikely to gain momentum in the Senate. The bad news is that the bill will likely be a model for future anti-financial reform efforts, which could gain steam under a Republican administration.
What stands out is not only how dangerous but also how poorly thought out much of this agenda is. The language has not been debated or even discussed, and it’s important to realize that this is beyond the normal partisan dynamics—i.e., conservatives trust business more, regulators less, and prefer private to public solutions. This bill would make regulators’ jobs functionally impossible, ultimately making our financial system riskier and more prone to fraud such as the Wells Fargo case. There are no adults in this room.
Many people realize the right has gone far outside reasonable boundaries on financial reform. But for those who don’t realize how crazy things have gotten, here’s an overview of what we think are the extreme ideas in this bill.
Extreme Policy #1: Erodes Independent Regulatory Agency Autonomy. The bill would require all major regulations (i.e., rules projected to have a $100 million or more impact on the U.S. economy) to be passed by Congress and signed by the president before they are effective. The bill further undercuts independent agencies by abolishing the “Chevron Deference Doctrine,” the 1984 Supreme Court decision which spelled out that the courts should defer to an independent agency’s rulemaking interpretations unless they are found to be unreasonable.
Both changes are not only extreme but would fundamentally undermine the independence of agencies charged with regulating, enforcing, and supervising financial markets and entities. This autonomy was intentionally put in place to shield regulators from the political fray and the whims of the president so they could deploy their expertise for technical rule-making. There are strong and effective mechanisms to keep independent regulatory agencies accountable, such as the Administrative Procedures Act (APA), the presidential appointment process, and legislative investigatory powers. Undermining this autonomy would only further weaken agencies that have been crippled by inadequate funding and disproportionate industry influence.
This policy goes beyond Republicans’ desired objective to dismantle Dodd-Frank. It fundamentally erodes the administrative rule-making process, which would lead to worse rules, more financial instability, and less effective enforcement of fraud.
Extreme Policy #2: Megabank Opt-Out. This gimmicky policy known as the “Dodd-Frank off-ramp” provision lets banks—primarily megabanks—off the hook for Dodd-Frank’s heightened prudential standards, such as living wills, short-term debt limits, and stress tests, as well as Basel III capital and liquidity requirements, provided those banks choose to maintain at least a 10 percent leverage ratio (i.e., the ratio of total assets to equity). Banks would only do this if it benefited them, though the risks would fall to the public. Even for those who want higher capital requirements, as we do, the off-ramp provision is inherently problematic because the 10 percent leverage ratio, while appealing, is both too low to work by itself and poorly designed, neglecting to regulate the entire bank balance sheet.
Adam Levitin testified in great detail about the dangers of the 10 percent leverage requirement and the inadequate illiquidity measures, which are fundamental causes of a financial crisis. He argues these requirements incentivize risky bank behavior because they do not require monitoring the quality of assets on the balance sheet. One of the authors recently wrote that leverage requirements should be higher, but a higher leverage requirement by itself can’t substitute for the rest of the supervisory requirements. It’s important to regulate the entire balance sheet, which includes liquidity, capital and type of debt (i.e., long-term vs. short-term).
Extreme Policy #3: Cripples the Institutions Best Positioned to Monitor Nonbank Risk and Shadow Banking. This bill would repeal the Financial Stability Oversight Council’s (FSOC) authority to designate nonbank financial institutions, like AIG and GE Capital, as systemically important (also known as SIFI designations). Many of these institutions play a role in shadow banking, a system of loosely regulated activities and entities that is a danger not only because it can cause contagion and panics, but also because it distorts the allocation of credit, which can result in putting resources toward unproductive and even fraudulent activities.
We argued in Untamed: How to Check Corporate, Financial, and Monopoly Power that the authority of FSOC and the Office of Financial Research (OFR, FSOC’s research arm) to evaluate and monitor emerging risks should not be controversial. They are best positioned to identify and study these risks because all the key regulatory agencies are members of this newly created body. Also, the designation procedures are lengthy, with multiple safeguards and opportunities for appeal. More transparency would strengthen FSOC’s procedures, but its authority should not be limited.
Extreme Policy #4: Splits the Federal Reserve in Half. This bill would detach the Federal Reserve’s banking regulatory policy (also known as macro-prudential regulation) wing from its monetary policy wing. The financial regulatory wing would be subject to the appropriations process, leaving this important piece of the Fed’s mission weaker and more vulnerable. It would also start to logically divorce the two parts of the Federal Reserve. One of the biggest issues before and during the crisis was the institutional separation of these critical central banking functions, which were unable to effectively communicate with each other. There have been efforts made to fix this problem, but this provision tosses them overboard.
Here’s one example of why this doesn’t work: The Federal Reserve pays interest on banking reserves, which has both monetary and macroprudential policy implications. Dodd-Frank requires banks to hold liquidity positions to deal with a credit crunch, which officials at the New York Federal Reserve believe could revive the bank lending channel of monetary policy. It’s impossible to separate these two functions, and we wouldn’t want to if we could; it would mean more risk and instability.
This is not an exclusive list of all the dangers this bill contains, but we wanted to highlight the systemic way anti-financial reformers seem to be planning to dismantle financial regulations and rule-making procedures. Congresswoman Waters and other Democrats on the committee didn’t introduce amendments because they believed the bill was beyond repair. We agree.