David R. Henderson  

Thoma on the Financial Choice Act

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Though it mostly went unnoticed, the House Financial Services Committee voted in favor of the Financial Choice Act. This legislation would substantially weaken the Dodd-Frank financial reforms.
So writes Mark Thoma in "Killing Banking Rules Will Invite a Whopper of a Recession," Fiscal Times, May 8, 2017.

But nowhere in his article does Thoma say what specifically is in the bill. Yes, the bill does weaken some Dodd-Frank regulations but one of the main ways is to give banks a safe harbor. If they have a high enough amount of capital, then they can avoid many of the rules of Dodd-Frank. One of the main justifications for Dodd-Frank is that it would cause banks, which are protected by deposit insurance and, sometimes, an implicit bailout promise, to take more prudent actions. But set the capital requirement high enough and then the bank is putting its own wealth at stake. So the justification for a lot of those rules goes away.

It's easier for big banks to comply with Dodd-Frank because of what I have called in the past "economies of scale in compliance." It's small banks that are being disproportionately hurt. I used to talk to Alec Arago, a local aide to my previous Congressman, Sam Farr (D-Cal). Alec told me a few years ago that he and Sam visited a small bank in Santa Cruz whose manager complained that the new law was strangling his business. A nice way around that it is to let the bank bear the risk and get out from under some of the worst rules.

See my Hoover colleague John Cochrane's excellent post for more detail. When you go to the post, click on his Chicago Booth Review article. For some reason, the URL is unfriendly and when I use it directly, in this post, readers can't get there.

By the way, at the Cato 40th Anniversary event, where I spoke on Saturday, one of the other speakers was former Congressman Mick Mulvaney, currently director of the Office of Management and Budget. My impressions of him were very good. He pointed out that it was a conversation with previous Cato Institute President John Allison a few years ago at a lunch on Capitol Hll that led Jeb Hensarling, Chairman of the House Financial Services Committee, to think about this idea for a way around burdensome regulations that still achieved the goal of having the entity that takes the risk be the entity that bears the risk.


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CATEGORIES: Regulation




COMMENTS (5 to date)
Lee W. writes:

The Cochrane link is broken

AlanG writes:

David, do you think banks will keep the necessary reserves in the absence of a legislative requirement? They pretty much did not during the mortgage meltdown.

David R. Henderson writes:

@Lee W.,
It doesn’t work. But see my fix above. Thanks for pointing it out.
@AlanG,
David, do you think banks will keep the necessary reserves in the absence of a legislative requirement?
You’re confusing reserves and capital.
Also, the whole post was about a legislative requirement. So I’m not sure why you’re asking the question.

Andy writes:

Sure, but the question is _how much_ capital would be necessary to avoid failures. The amount in the CHOICE ACT is less than many analysts think is needed, such as the recent Minneapolis Fed report. It's still a long ways from narrow banking.

Cullen writes:

There are definitely economies of scale in compliance. It's a lot easier for a Chase, JP Morgan, etc. to hire people dedicated to Dodd-Frank compliance, AML compliance and so on. This is mitigated a little by different standards applied to sizes of banks. The OCC, for example, issues guidance for small, midsize, and large banks and in my experience, regulators look for regulatory programs to be tailored to the size and complexity of a financial institution (their term of art, not mine). I imagine that this lead to clustering along the limits rather than strictly leading to an advantage for larger banks.

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