Banking on Change: What Dodd-Frank did—and didn’t do—for the financial industry
Though we’re now a decade removed from the beginning of the Great Recession, banks are still feeling the ripple effects of the economic meltdown as well as the resulting legislation aimed at preventing something similar from happening again.
In 2010, Congress introduced the Dodd-Frank Act. The legislation increased the amount of capital banks are required to hold in reserve to weather financial storms, required banks to keep more of their assets liquid, and subjected larger banks to annual stress tests administered by the Federal Reserve to make sure they can withstand a comparable crisis to that of 2008.
The Dodd-Frank Act also introduced the Volcker Rule, which prevents banks and their affiliates from making certain kinds of speculative investments. It also created the Consumer Financial Protection Bureau, which is intended to protect consumers from unfair, deceptive or abusive financial products and services.
“There was a meltdown of a part of the financial system that was incredibly damaging to the economy and a lot of people—and it never should have happened. Congress—I think very legitimately—said, ‘What in the world is going on here? We need to make sure this doesn’t happen again.’” – George Sutton, Attorney, Jones Waldo
Despite its of goal of keeping too-big-to-fail banks in check, many in the financial industry feel that Dodd-Frank missed the mark—failing to slow the proliferation of mega-banks while simultaneously stifling the growth of small- and medium-sized banks.
Now that Republicans are in control of the House, Senate and White House, there is a chance the Dodd-Frank Act will be partially or fully repealed. Here’s why the banking industry would welcome the change.
Fixing the wrong problems
Over the past 30 years, Jones Waldo attorney George Sutton has seen just about every part of the banking industry. He’s served as Utah Commissioner of Financial Institutions, run an industrial bank, and specialized in financial and regulatory law.
He thinks Congress was right to step in after the Great Recession. “There was a meltdown of a part of the financial system that was incredibly damaging to the economy and a lot of people—and it never should have happened,” he says. “Congress—I think very legitimately—said, ‘What in the world is going on here? We need to make sure this doesn’t happen again.’”
But he doesn’t believe policymakers came up with the right solutions or even addressed the right problems. “The wrong solutions were focused on the depository banks—those taking deposits and insured by the federal government,” Suttons says.
The bigger problem, he says, were the securities companies that are not federally insured. Though banks regularly originate home loans, most are eventually sold off to other groups that pool them into securities and then sell them to investors.
“That’s where the problem was,” Sutton says. “The rating agencies like Standard & Poors and Moody’s were putting triple-A ratings on mortgage-backed securities that were full of a staggering number of bad loans.”
When there’s a downturn in the economy, traditional depository banks can dial back on issuing new loans and live off the interest from previous loans, Sutton explains. Mortgage companies, however, live off the fees they earn from originating the mortgage.
“Those companies, once they ran out of good mortgages to make, began making bad ones and putting lipstick on the pig and pumping those loans into the securitizations. When the investors started to figure that out, they dumped the securities they already held and stopped buying new ones. That collapsed the credit market.”
Rather than focusing its new regulations on depository banks, Sutton thinks Congress should have focused on the securities companies and the rating agencies.
“There are easy ways they could have done that. They could have required the rating agencies to be licensed and examined them to make sure they are taking a deep dive into the loans that are going into the securities they rate,” Sutton says. “Instead, they turned the bulk of their attention to the depository institutions. A lot of new programs were imposed on the banks—some of which were good—but some were overdone and that’s the issue now.”
Sutton says one part of the Dodd-Frank Act that should be reevaluated by Congress is the Volcker Rule. “The way it’s pitched, it prohibits a federally insured bank from using deposits to engage in high-risk investing,” he says. “That’s nonsense. For decades there have been not just regulations, but laws outlawing banks from engaging in speculative investing.”
The real targets of the Volcker Rule are the affiliates of banks, says Sutton, which do not hold federally insured deposits. “The purpose of the rule was to make diversified holding companies get rid of their banks by making it a nuisance to own a bank. But the real effect is that really inhibits the ability of medium-sized banks to raise capital.”
“Instead, they turned the bulk of their attention to the depository institutions. A lot of new programs were imposed on the banks—some of which were good—but some were overdone and that’s the issue now.” – George Sutton, Attorney, Jones Waldo
Taking choice away from consumers
In addition to harming medium-sized banks, the Dodd-Frank Act has also been detrimental to small community banks, says Richard Beard, CEO of People’s Utah Bancorp and Bank of American Fork.
“The idea behind too-big-to-fail is that you have some banks that are so big that they’re the lifeblood and the freeway for a capitalistic system. If they go down, you do almost irreparable damage to the economy,” Beard explains.
Dodd-Frank’s regulations, annual stress tests and heavy reporting requirements are meant to ensure that these large institutions are strong enough to withstand failure if faced with another financial crisis. Though large banks have the infrastructure to handle these compliance requirements, Beard says most community banks do not.
The unintended result of these regulations is the disappearance of community banks, he says. “Twenty years ago, there were 9,000 banks in the United States. There are about 5,000 today. Smaller banks cannot comply with all these regulations and uncertainty, so they either get out of the business or sell.
“Paradoxically, it’s made the too-big-to-fail banks even stronger because they have the ability to hire the regulatory lawyers and everything else to comply with these complex rules,” Beard says. “If you look at the statistics, the number of banks controlling the assets of the United States has become more concentrated post-Dodd-Frank than before.”
“Twenty years ago, there were 9,000 banks in the United States. There are about 5,000 today. Smaller banks cannot comply with all these regulations and uncertainty, so they either get out of the business or sell.” – Richard Beard, CEO, People’s Utah Bancorp
All of this spells trouble for consumers, Beard says. “In a capitalistic society, more choices are better than fewer choices. We now have five banks that own almost half of the assets in all the U.S. That may not be a monopoly but it’s getting darn close.”
When community banks close, consumers have less choice in where they deposit their money and have a tougher time finding funding. Beard explains that lenders are more likely to take risks on loans if they are familiar with the community, the borrower, and his or her individual situation.
“If you’re a large national bank, you don’t even really know a lot about Utah because it’s such a small market, and you certainly don’t know the difference between the needs of people in American Fork versus Saratoga Springs,” Beard says.
Those who do qualify for a loan are now presented with more paperwork than they were before 2010 and are subject to longer timelines. “The Dodd-Frank Act has slowed down the process dramatically and consumers can’t get answers as quickly as they did before. That is theoretically protecting the consumer but in reality it’s making customers miss interest rate locks and [other key dates] because of the timing that Dodd-Frank has artificially imposed on the industry,” he says.
Don’t count on new legislation
With Republicans leading the House, Senate and White House, most people in the financial industry assumed the death of the Dodd-Frank Act was imminent. However, given the chaos surrounding the first year of President Donald Trump’s term in office, nothing is certain.
George Sutton feels that even if the laws do not change, over time, the administrators will. “We’re just in the process now of seeing a change of administration at the agencies. Hopefully the new people will have a better understanding of the markets, the industry and the needs of the consumers,” he says. “You can take all the laws and regulations and they pale in significance to the people who are running the agencies. Good people will make the laws work. Bad people will make even the best laws unworkable.”
Though he was initially hopeful the more onerous parts of the Dodd-Frank Act would be at least trimmed back under President Trump, Richard Beard now feels less optimistic. “I can only speak for myself, but I’m now somewhat reserved about whether to be hopeful.”
With all the other issues facing the president and the country, he says, “I’m worried that what is really important to the banking industry is a sideshow compared to other big issues that seem to be on the president’s plate.”
In the meantime, the financial industry has no choice but to wait to see what happens next.
“We’re just in the process now of seeing a change of administration at the agencies. Hopefully the new people will have a better understanding of the markets, the industry and the needs of the consumers. You can take all the laws and regulations and they pale in significance to the people who are running the agencies. Good people will make the laws work. Bad people will make even the best laws unworkable.” – George Sutton, Attorney, Jones Waldo