Last week, President Trump signed an order asking for a review of the Dodd Frank regulatory law. This law, about 24,000 pages of regulations evolving over multiple years, has commonly been vilified for holding back the economic recovery after the credit crisis. Some effects of Dodd Frank have been very evident such as a significant decline in the number of community banks, which do not have the resources to deal with this cumbersome regulation; and more fees for customers as banks try to recoup costs. Other effects are less obvious to the lay person. They include a sharp rise in deposits and lending activities at the nation’s five largest banks, which have consolidated their positions into even larger institutions; and a similarly sharp rise in the unregulated ‘shadow banking’ system. Some small businesses were frozen out of the credit markets; many mortgage borrowers are now shocked at the pickiness of banks, and at how long it now takes to get a loan. We’ve had clients sign as many as three loan extensions while banks try to gather the information they need to make a simple home loan.
Benefits of Dodd Frank are even more obscure. They include better transparency for certain interbank transactions, derivatives trading, and a clearer path for more regulation since reporting requirements under Dodd Frank spiked.
The main point of the legislation – to protect the banking system against ‘too big to fail’ – has not been tested. Thus, success is difficult to determine. However, we will note that since the first bank was formed in this country, there have been numerous ‘banking crises’ – some of which were really, and some of which were really not – and ever increasing regulations. Somehow we have never managed to repeal banking crises, and I am not optimistic that Dodd Frank has done it, either.
The executive order contains language ordering a review, with an eye to diminishing the regulations at some point in the future. This review could take months or years. In the meantime, bank stocks have become pretty frisky, rallying strongly for this and other reasons. Due to overreach by regulators, banks are often told which loans they can and cannot make. Rules have also required banks to apply to regulators in order to hike dividends or buy back shares. These factors have left banks with capital far in excess of regulatory requirements, money that is simply lying fallow, and not a minute sum. CitiGroup itself is estimated to have over $25 billion of excess capital. This capital could go to loans, if regulations were eased, or dividends and share buybacks.
Should banks have the opportunity to use this dormant capital, earnings could increase, but more importantly, the capital could goose the economy. Unfortunately, as much as Main Street loves to hate banks, you cannot have a healthy, productive economy without healthy, active banks lending money. That’s why banks exist.
It remains to be seen whether Trump’s order will lead to anything, but the signs are hopeful.