Forbes - Alex Verkhivker - 10 May 2017
Earlier this month, the House Financial Services Committee held hearings on the Financial Choice Act, a 500+ page bill introduced by U.S. Representative Jeb Hensarling (TX-5). The Texas Congressman chairs the House Financial Services Committee, is a proponent of the free markets and has a stronghold over the future of the U.S. financial system. He wanted to free up America’s small banks and credit unions from the constraints of Dodd-Frank ever since Trump considered running for office. Democrats have been wary of Hensarling, including Sen. Elizabeth Warren who has viewed the bill as a “handout to Wall Street.”
The reality, however, is that the current financial regulatory system isn’t working. “Somebody has to protect consumers, not just from Wall Street but protect them from Washington as well,” noted Rep. Hensarling when being interviewed by National Public Radio. “Free checking at banks has been cut in half. Banking fees have gone up. Working people are finding it more difficult to get mortgages.” Rep. Hensarling has taken to task issues like bank stress testing, debit card overage fees, and bank bailouts in the Financial Choice Act - a bill that is aimed at “creating hope and opportunity for investors, consumers and entrepreneurs.”
At the heart of the matter is creating a resilient, stable financial system that affords economic opportunity for Americans. Dodd-Frank’s excessive regulatory complexity has resulted in a financial system that limits credit and access to capital for the small guys. Small banks have been saddled with confusion and overlapping regulations that limit their ability to give out loans to small businesses. Scholars of law and economics have studied the dynamics of financial regulation, focusing on things like whether there’s just the right amount of capital banks should hold, but haven’t given guidance on how regulation should be structured.
The Financial Choice Act is symbolic of what’s missing from Dodd-Frank, including ways to get bank lending to rise and increasing the number of financial options for small players who’ve been hurt by scandals at the large financial institutions on Wall Street. “Our plan replaces Dodd-Frank’s growth-strangling regulations on small banks and credit unions with reforms that expand access to capital so small businesses on Main Street can grow and create jobs,” Mr. Hensarling noted earlier this month after the House Financial Services Committee voted 34-26 along party lines to dismantle elements of the Dodd-Frank regulation.
Elements of the Financial Choice Act have created tension even amongst Republicans, most notably the Durbin amendment – which sets a cap on debit-card transaction fees. Rep. Hensarling hopes to eliminate that cap and has noted that more discussion will need to take place on both sides of the aisle as well as both sides on this issue. Another issue that will need more debating is the average leverage ratio banks must meet in order to get relief from restrictions on capital and dividend payouts. Hensarling has predicted that some of the biggest Wall Street firms would have to raise “several hundred billion dollars in new equity” if they want to be exempt from regulations on capital and dividend payouts.
In order to drain the swamp and get the economy working for Americans, Hensarling’s bill provides an “off-ramp” from Dodd-Frank’s regulatory regime and requires that the different conditions under which stress tests are performed be made open to the public and given their appropriate comment period. Some have argued that it’s uncertain whether Rep. Hensarling’s bill would be a boom or bust for Wall Street’s biggest bankers. What is apparent is that the Financial Choice Act is meant to free up banks from a number of regulations should they bump up their leverage ratios – the figure that shows how safe a lender is by calculating the amount of equity capital it has relative to total assets.
Interestingly, academics have studied financial crises and have tried analyzing good ways to regulate the holding of a bank’s liquid assets. Two of these scholars – Douglas Diamond and Anil Kashyap from University of Chicago’s Booth School of Business – have been at the forefront of the research looking into this. In an interview with MIT Sloan School of Management’s Newsroom, Diamond noted that there’s a well-known paradox about regulating liquidity.
“The point about having some liquidity around is that if people draw money out, you have assets that you can unload without any losses because they’re so liquid. You want to keep it as a buffer against withdrawals. There’s a bit of a problem, though, when you require people to hold liquidity because it can’t be used to meet the withdrawals—you can’t use; it’s dead. There are some jokes about this because it seems like a contradiction. But in our model, [Kashyap and I] show that in many cases it’s actually not a contradiction because the point of requiring a certain amount of liquidity in particular circumstances is to give the bank incentive to hold the right amount of liquidity in excess of the amount required. Banks may not in general want to hold enough liquidity, but certain well-structured ways of requiring them to hold particular amounts of liquidity gives them proper incentives to hold amounts above that, which would be close to what society would want them to hold.”