In 2010, the Dodd-Frank Act attempted to limit future risks to the financial system with a laundry list of new restrictions and standards for financial institutions. Five years later, it's unclear whether the wave of new regulation has been a worthwhile trade-off.
House Financial Services Committee chairman Jeb Hensarling labeled Dodd-Frank a failure in his July 2015 Wall Street Journal editorial. Hensarling put his finger on the real issue: "It wasn't deregulation that caused the crisis, it was dumb regulation." Meanwhile, financial industry insiders argue that the Volcker Rule as well as regulations regarding capital adequacy, qualified mortgages, risk retention, derivatives and liquidity have all led to higher compliance costs and fewer business opportunities to generate a profit. They say the combined effect of Dodd-Frank and its higher operating costs also restrict credit availability and reduce liquidity in the economy.
Assuming this is the case, the critical policy issue is whether these costs are commercially reasonable when measured against the benefits that the economy and consumers will realize as a result of new regulations. That question is still largely unanswered.
It's worth noting that the public's negative perception of the financial industry is still intact. According to a recent survey of 1,000 Americans on behalf of the progressive nonprofit group Americans for Financial Reform and the Center for Responsible Lending, 91% of voters believe that it is important to regulate financial services to level the playing field for consumers. Voters would support even more oversight of financial companies by a margin of 3:1.
But the financial industry's perspective on regulation is quite different. The evidence that Dodd-Frank is increasing operating costs and altering business decisions is substantial.
In 2013, the Federal Reserve Bank of Minneapolis found that staffing needs to cope with the new regulations could result in a reduction of 14 to 45 basis points in the median profitability among banks with less than $50 million in assets. The study projected that the reduction would result in between 6% and 33% of those banks becoming unprofitable. And a 2014 survey of 200 community banks by the Mercatus Center at George Mason University revealed that customers are already seeing the effects of the increased regulatory burden through reduced product and service offerings, particularly mortgage credit availability.
At the other end of the bank-size spectrum, a study by Federal Financial Analytics in 2014 concluded that "quantifiable" regulatory costs faced by the six largest banks have doubled since the financial crisis, rising from $34.7 billion in 2007 to $70.2 billion in 2013.
The only way to evaluate the appropriateness of Dodd-Frank's costs is to monitor the economic benefits that it creates. This is an admittedly complicated task. The chief benefits cited by the law's supporters are that it makes the financial system safer and protects consumers from abuses — both of which are difficult to quantify. Yet it is incumbent upon the government to find a way to measure the ongoing efficacy of its regulations. Otherwise, we have no way of knowing whether they are helping or harming economic vitality.
Recent business decisions involving "too big to fail" banks and nonbank financial companies clearly illustrate the economic consequences of Dodd-Frank. Five years after the law was enacted, four large non-bank financial companies have been classified as systemically important financial institutions by the Financial Stability Oversight Council, gaining them admission into Dodd-Frank's enhanced prudential regulation laboratory. A pending challenge to one such designation asserts, among other things, that the government never weighed the measurable costs of increased regulation as a SIFI against the likely economic benefits.
Even more telling is that one of these companies has decided to sell a substantial portion of its banking and banklike businesses in order to scale down and avoid stricter regulation. Admittedly, there are many in and out of government that would consider this divestiture and downsizing a great success in the name of safer, more supervised financial markets. For those who appreciate the delicate balance between regulation and free markets, it is the canary in the coal mine.
No matter who is in office in the future, it's unrealistic to think that a majority of Dodd-Frank regulations can be reversed. But in order to ensure that financial services remain broadly available and efficient, some practical changes should be implemented.
First, every new financial law and regulation from this point forward should come with a real expiration date, at which point it must either be reenacted based on a comprehensive cost-benefit economic analysis or expire.
Second, the FSOC should evaluate systemic destabilization and dislocations that can occur because of overregulation and poorly constructed regulations as a threat equal to that created by financial companies that are too big or under-regulated.
Third, Congress should stop enacting detailed financial services laws that resemble punch lists and allow regulators, who are best positioned to make finely calibrated decisions about financial safety and soundness, to exercise their expert discretion.
Fourth, government resources should be focused on maximizing the quality of regulation. Regulators should get real-time financial information about the companies they oversee using the most sophisticated data collection and risk management evaluative tools that are available.
Finally, the government should closely monitor the market to determine whether consumers are willing to pay more for less financial services. As a consumer, I would want to know if all this new regulation will actually avert the next financial crisis. In the past, it never has.
Thomas P. Vartanian is the chairman of the financial institutions practice at Dechert LLP and a former regulatory official at two different federal banking agencies. He routinely represents financial institutions and related parties in transactional, regulatory and enforcement actions, including parties that have filed an amicus brief in support of MetLife's challenge to SIFI designation.