Bench Memos

More on Dodd-Frank and Community Banks

It should come as a surprise to no one how costly and unwieldy Dodd-Frank is proving to be. Dodd-Frank regulators have missed 142 (59.9 percent) of the 237 passed rulemaking deadlines, and while the Panama Canal was built in 20 million man hours, Dodd-Frank’s already-written rules span 7,365 pages, at a cost of around 24 million annual labor hours. This cost might make sense if it actually prevented the next financial crisis. However, by relying on unrestrained bureaucrats — removed from government oversight — to design our financial system, it does far from it, instead only favoring large financial institutions at the expense of small ones. Fortunately, the separation of powers restrains this mistaken philosophy, checking government’s inherent tendency to favor large institutions.

Government’s institutional bias in the financial system — when left unchecked — is toward the powerful. Big banks can afford expensive lobbyists to secure favorable regulations, and rely upon regulatory compliance officers and high profit margins to weather the remaining regulatory storm. Community banks aren’t so lucky. They can’t afford expensive lobbyists, and must either accept lower profit margins, drastically alter their business model, or shut down.

It is easy to see this bias in action; the federal government’s policies consistently favor the largest banks. While 190 firms borrowed $1.2 trillion from the Federal Reserve from 2007 to 2009, the largest six firms accounted for $460 billion in borrowing, and overall, “The six largest banks received a total of $1.27 trillion [!] in government support.” Similarly, with the Chrysler auto bailout, well-connected unions secured a handout, at the arbitrary expense of the less powerful Indiana pension fund.

Dodd-Frank is a perfect case study for this phenomenon, on full display in the Consumer Financial Protection Bureau. Czar Cordray — with centralized, near-unchecked authority to interpret federal consumer-finance laws for large and small banks alike — has great discretion to harm consumers by forcing small banks to stop offering particular products, leave certain fields, or shut down completely, all the while leaving large banks relatively unscathed. The CFPB has already caused Big Spring National Bank of Texas, a plaintiff in a constitutional challenge to Dodd-Frank, to leave the mortgage industry, and this is most likely just the tip of the iceberg. In Florida, for example, 64 percent of community banks and credit unions expect to hire more compliance staff in the next three years, often requiring a doubling of their compliance division.

Smaller banks are now also more likely to merge with larger ones. Jeff Blumenthal explains that 108 banks were acquired during the first half of 2012, 86 of which had assets amounting to less than $500 million. Chris Cole, of Independent Community Bankers of America, argues that costly rules could force “about 200 community banks . . . [to] merge out of existence.”

But community banks weren’t the ones to blame for the current financial crisis, and their loss could actually exacerbate the problems Dodd-Frank was designed to remedy. Community banks rely upon relationship banking to do much of their lending, and can thus serve otherwise overlooked customers — including farmers and rural residents. One bank president explained that the CFPB weakens this relationship-based model of lending because “it doesn’t give us the flexibility to maybe create a product for you that fits you best,” resulting in “more vanilla products.” While Dodd-Frank’s defenders pat themselves on the back for not letting the financial crisis go to waste, consumers grapple with fewer banks that know their name and products that meet their needs. And increasing the size of large banks gives more market share to the institutions that historically have behaved less transparently and responsibly than their smaller counterparts.

The separation of powers is a partial antidote to this problem, ensuring that no one branch of government accumulates too much power. Members of Congress face more scrutiny for their legislation than bureaucrats do for their regulations, and it is harder to influence three branches of government than it is to influence a nameless bureaucrat. If one branch of government favors big banks at the expense of consumers, another can rein it in. Although this makes governing difficult, it does so by design; our Founding Fathers had a well-grounded suspicion of absolute power.

Separation of powers is not a silver bullet, and big banks will still find ways to secure favorable treatment. But it at least gives consumers and community banks a fighting chance, putting power closer to the people, and farther away from, as Ronald Reagan once put it, “a little intellectual elite in a far-distant capitol [who think they] can plan our lives for us better than we can plan them ourselves.”


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