A little more than two years ago President Obama signed the Dodd-Frank bill, promising to end taxpayer-funded bailouts.
Of course there is no such end in sight.
The argument for this legislation was that government regulators needed more authority and discretion to deal with the largest financial firms. Instead Dodd-Frank has had two main effects. It has solidified the crony-capitalism practice of the government picking winners and losers, and it has unleashed an avalanche of confusing, sometimes conflicting regulations on everyone, including community and regional banks—regulations that add plenty of costs but little protection.
The financial reform that we truly need is more systemic: reform the core structure of the market in a way that enhances financial stability. We should start by increasing capital standards for megabanks: Bank of America, Citigroup, Wells Fargo, JP Morgan, Morgan Stanley and Goldman Sachs.
In this discussion, Dodd-Frank supporters often point to the authority they gave regulators to increase these institutions’ capital standards and make them safer. However, those regulators, led by Federal Reserve Chairman Ben Bernanke, have refused to use that authority so far. I’m concerned that instead they’re relying on the next group of “smartest guys in the room” to get it right in the next financial crisis.
Recent events don’t bode well for that approach. Just look at the surprise multibillion-dollar losses at J.P. Morgan Chase earlier this year. Neither the regulators nor CEO Jamie Dimon—the single smartest guy in the room (just ask him)—caught those problems.
Similarly, supporters of Dodd-Frank claim that regulators now have the authority to fire board members of failed financial companies and wipe out stockholders. But the same regulators are also granted authority to decide which creditors get paid and to what extent, and to create “bridge banks” used by the Federal Deposit Insurance Corporation to continue operations of an insolvent bank. How do you think this will actually shake out in the next financial crisis? My money is on the regulators using their authority in the name of “financial stability” to once again bail out Wall Street and its creditors, perhaps with some feel-good (and probably politicized) restructuring of those firms for window dressing.
A major drawback of Dodd-Frank is that it has swelled the cost of over-regulation on all institutions and thus consumers. The legislation has led to over 400 new rules—an avalanche of regulations that has increased economic uncertainty and the cost of doing business while accomplishing little to increase safety in the financial system.
The burden weighs most heavily on smaller banks, putting them at a competitive disadvantage and helping the megabanks grow even bigger and more dominant since the financial crisis. During the crisis, the nine largest banks and securities firms consolidated into what are now the six largest bank holding companies. As a result of these mergers, total bank assets at three of the four largest megabanks grew by an average of more than $500 billion.
The assets of the six biggest U.S. banks currently equal 62% of U.S. gross domestic product, up from 18% in 1995. Together, these six banks are now twice as large as the rest of the top 50 U.S. banks combined. This isn’t making the financial system safer either.
Instead of Dodd-Frank’s over-regulation, we should require a higher capital ratio for megabanks. And this ratio should be clearer and less vulnerable to being gamed than the overly nuanced, subjective Basel III formula. This will cause the megabanks to either be far better able to weather the next crisis without a bailout, or it will create market incentives for them to spin off parts of their business into separate entities. They will still be plenty capable enough of handling the demands of very large business clients, including by joining with other large banks on the very largest transactions.
These more fundamental reforms will allow us to simultaneously lessen the crushing burden of hyper-detailed, often unclear or conflicting over-regulation. This is essential to ensure a healthy financial sector, a newly revived economy, and the survival of the valuable, unique tradition of community and regional banks in America.
Mr. Vitter, a Republican from Louisiana, is a member of the Senate Banking Committee. This piece originally appeared in the Wall Street Journal.