With the GDP’s growth rate for the most recent quarter now downgraded to 1.3 percent, it is useful to consider what the financial system and the economy will look like in the future if President Obama is reelected, which would seal the Dodd-Frank Act into place.
First, it is likely that the economy’s growth would remain well below its potential. Before the enactment of Dodd-Frank in the third quarter of 2010, the economy had emerged from recession and was growing at 2.5 percent over the post-recession quarters. Not a burst like the one we saw under Reagan, to be sure, but definitely a recovery. However, after Dodd-Frank was signed into law, the economy’s growth rate slowed; it has averaged less than 2 percent in the seven succeeding quarters. Dodd-Frank is by far the most comprehensive and restrictive financial regulatory legislation since the Depression era; its effect on regulatory costs for financial firms at all levels has been and will continue to be substantial, with severe adverse consequences for credit availability.
But that isn’t all. The Financial Stability Oversight Council — an agency established under Dodd-Frank and consisting of all the federal financial regulators — has now begun work on identifying the nonbank financial institutions that will be declared systemically important financial institutions (SIFIs). These will be large firms — insurers, holding companies, securities firms, finance companies, hedge funds, and perhaps money-market mutual funds — that the FSOC will identify as potential sources of instability in the U.S. financial system if they should fail.
Once those institutions are named, they will inevitably be considered “too big to fail,” adding materially to the problem that already exists in the banking industry. With their perceived government support, they — like the biggest banks — will have funding advantages over their smaller competitors, promoting consolidation and changing competitive conditions in every sector of the financial system where a SIFI is designated.
Impairment of competition, however, is not the most serious problem. Under Dodd-Frank, nonbank SIFIs will be put under the jurisdiction of the Federal Reserve for “stringent” regulation. Like banking organizations, they will thereafter be focused on currying the favor of the Fed, which will open them up to the kinds of alliances between government and large firms that are the essence of crony capitalism. All these large companies will have to think twice before criticizing or protesting government policies. That is why you will not find an example of a large bank suing the Fed. In the future, then, SIFIs will be added to the timid group that will fear to challenge the Fed or the administration in power, and will be susceptible to demands for backing administration policies.
And it is not only SIFIs that will fear retribution for challenging the government. Title II of Dodd-Frank gives the secretary of the Treasury the authority to seize any financial firm he believes is likely to fail in the future and hand it over to the FDIC for liquidation. If the firm objects, the secretary can apply to a court for a ruling, but the court has one day to decide whether the secretary has acted unreasonably. Stays and appeals are prohibited. If the court does not act in that one day, the firm is remitted to the FDIC “by operation of law.” Again, it will be a bold firm that challenges the administration in power if the Treasury secretary has this authority.
For this reason, if Obama is reelected, the U.S. financial system’s historic independence from government will be substantially changed. Like the health-insurance industry under Obamacare, the financial industry will fall under government control.
The Consumer Financial Protection Bureau (CFPB) is another Dodd-Frank creation that has powers of unprecedented scope for a regulatory agency. First, the bureau has authority to take action against any company (except insurance and securities firms) that has financial relationships with consumers. Every firm, from the largest bank to the smallest check-casher on Main Street, is under its jurisdiction.
The act gives the CFPB the authority to prohibit “abusive” practices — a highly discretionary term that the CFPB’s director has refused to define by regulation, leaving its meaning to become clear through enforcement actions over time. For the firms within its purview, offering new products to the public will become a form of roulette, with an enforcement action awaiting the losers.
The burden of regulatory costs will also be extraordinary; a current CFPB proposal for a simplified form of mortgage disclosure tops out at over 1,000 pages.
Finally, the agency is headed by a single administrator, appointed for a five-year term and not subject to removal other than for cause. This eliminates one element of the political control over the government’s actions envisioned by the Framers. The bureau’s unprecedented funding method eliminates another: By statute, the CFPB is allocated a portion of the Fed’s cash to support its activities, depriving future Congresses of their constitutional power of the purse.
Mitt Romney has said that he will press for the repeal and replacement of Dodd-Frank. Given the other issues on his plate if he is elected — reining in out-of-control debt, entitlement and tax reform, repeal and replacement of Obamacare, preventing Iran from developing nukes, and reversing the decline of U.S. power — Dodd-Frank will not be an immediate priority. Still, much of its mischief can be halted by replacing the people who have the power to implement its provisions — the secretary of the Treasury and the financial regulators on the FSOC. The serious dangers for the U.S. economy implicit in the Dodd-Frank Act are yet another reason for Romney to be given that opportunity.
— Peter J. Wallison is a senior fellow at the American Enterprise Institute. He is the author of Bad History, Worse Policy: How a False Narrative about the Financial Crisis Gave Us the Dodd-Frank Act, to be published in January.