Supporters of the Dodd-Frank Act are crying “foul” over the appointment of a Trump administration official as acting head of the Consumer Financial Protection Bureau, and more generally the administration’s plans to alter rules stemming from the 2010 financial reform law. But others see the irony in their protests.
President Obama was not going to be in the White House forever. And a change in administration brings management change at executive and independent regulatory agencies. If laws are well-crafted, the change should not portend wholesale changes in financial regulatory policy. But when the law at issue is Dodd-Frank — management changes can bring sweeping revisions to the regulatory environment. Only now, as the new administration takes root, are Democrats recognizing and understanding the flaws in the law they passed and have so staunchly defended.
For years, Republicans on the House Financial Services Committee have identified serious legal problems in the drafting of Dodd-Frank. Subsequent court decisions have substantiated the merits of a number of these criticisms. These problems range from the unaccountable and unconstitutional governance structure of the CFPB, to unelected officials at the Federal Reserve Board and Financial Stability Oversight Council being empowered with massive regulatory discretion that can be exercised with few if any checks and balances for regulated firms or the Congress that delegated the powers.
Over the course of U.S. history, there have been many sea changes in administration priorities. Even when policy changes involve financial regulatory policy, the issues are usually too arcane to generate much controversy. Few regulatory debates have triggered the types of legal battles and heated protests as the current back-and-forth over how to handle agency transitions.
To make sense of this, one must understand that Dodd-Frank gave the financial regulators vast new powers that enabled the managers of these agencies to decide, within very broad boundaries, the character of financial regulation. How these powers are exercised is largely determined by who is in charge of the financial regulatory agencies. Dodd-Frank does very little to constrain the exercise of regulatory power — which explains why, under President Obama, Republicans pushed for reforms and why under president Trump, Democrats are so vigorously opposing management changes at the financial regulatory agencies.
As long ago as 1750 B.C., the Babylonian king Hammurabi recognized the value of a just, stable and transparent system of laws for maintaining domestic tranquility and fostering growth. Hammurabi’s code of laws exhibited basic legal principles that are still relevant today: a law should be written so that compliance is transparent; citizens are innocent until proven guilty; and false accusations must have consequences.
Compared to Hammurabi’s code, Dodd-Frank fails miserably. For example, it creates new powers to be exercised by the financial regulatory agencies without circumscribing clear limits on these powers. In many instances, Dodd-Frank empowers regulatory agencies themselves to write the laws they enforce by directing regulators to craft new regulations with the force of law. Often the requirements for legal compliance with these mandates are murky at best, and there is no penalty for agencies that unjustly accuse institutions of violations.
A good example of Dodd-Frank’s failure is the CFBP’s overreach on indirect auto lending. The CFPB expanded its Dodd-Frank mandate and imposed new regulations on auto lenders in the form of guidance, and assessed fines for alleged violations. The accused institutions were never proven to be guilty. The Government Accountability Office recently ruled that the CFPB auto lending policy was a rule, not guidance, for the purposes of the Congressional Review Act. The GAO’s opinion effectively scraps the rule while the CFPB decides whether to resubmit it to Congress for review. But the CFPB suffered no penalty for its overreach.
Another example that violates Hammurabi’s principles of jurisprudence is the Dodd-Frank requirement for annual Federal Reserve Board stress tests. Section 115 of the financial reform law requires the Fed to periodically evaluate the capital adequacy of designated institutions under baseline, adverse and severely adverse conditions.
The rub is that Congress empowered the Fed to specify what the law means by adverse and severely adverse economic conditions. It also empowered the central bank to decide on the methods and techniques used to evaluate whether individual institutions will remain adequately capitalized under hypothetical adverse and severely adverse conditions. The law does not require the Fed to publicly disclose these techniques even though, as part of the process, the Fed assesses the veracity of individual institutions’ stress tests. Banks must build stress test models, but can only guess whether their models will be deemed compliant.
After thousands of pages of guidance and hundreds of millions of dollars spent trying to build compliant stress testing models, banks are still unsure how to comply with Section 115. This nagging issue has pushed the Fed to release an “enhanced transparency” proposal. But the proposal promises to clarify little regarding what constitutes a compliant model.
The main impact of the Fed’s “enhanced transparency” disclosure is likely to be additional bank expenditures to ensure that bank models reproduce loss rates that mirror those reported by the Fed, regardless of the bank’s actual business history of losses. The situation is even more egregious when one realizes that there is no requirement in Dodd-Frank that the Fed’s own stress test models produce accurate predictions of covered institutions’ losses under adverse and severely adverse economic conditions. There are no blind scales of justice — the Fed alone decides a bank’s guilt or innocence.
One could continue with examples, but the point is that the current outcry from Dodd-Frank supporters over the Trump administration’s approach highlights the need for better-crafted financial legislation. The debate about who runs the financial regulatory agencies would be less controversial if the law tightly circumscribed the agencies’ powers and responsibilities and precluded the crafting of legal interpretations that allow regulatory agencies to expand their jurisdiction or pursue political agendas.
Hammurabi was right. Legal stability is a prerequisite for prosperity and domestic tranquility. The change of an administration should not mark a massive change in the scope or rigor of financial supervision and regulation. The power to effect major changes in the financial regulatory environment should rightly be vested in the legislative branch. It is Dodd-Frank itself, not the new administration, which is the source of the recent outcry.