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With the debacle of health care reform in the rearview window, conservatives in Congress and the White House are turning their sights on President Barack Obama’s financial regulations. All indications are that the GOP is more unified in how they want to go about “repealing and replacing” these regulations — most of which were passed as part of the Dodd-Frank Act in 2010.
For the past six years, these reforms have provided key protections to consumers and stability to the banking system by protecting consumers. They’ve made banks more resilient and created stability in the capital markets.
Expect Republicans, as in the case of the health care bill, to attack the regulations by way of the budget: specifically, through the “budget reconciliation” process that eliminates the threat of a Democratic filibuster.
Contrary to many headlines, the executive orders President Donald Trump has released so far related to banking regulations do little more than call for reviews. Reviews are the sort of thing a well-run administration would normally have quietly done during the transition. True, Trump can do damage to financial reform when he appoints regulators hostile to enforcing the law. But undoing the regulations won’t be as simple as flipping a switch, or swapping out one set of political appointees for another. There would have been no point in passing something like Dodd-Frank if a Republican president could overturn it by fiat.
It is unlikely, also, that Congress will overturn Dodd-Frank with a big bill. The Senate is the crucial threshold, and the legislation Republicans have floated is so aggressive it’s unlikely it can get 60 votes. The CHOICE Act that has been proposed by Republicans in the House would repeal or dismantle virtually every part of Dodd-Frank, from the Volcker Rule (which prevents commercial banks from making certain kinds of speculative trades), to the Consumer Financial Protection Bureau, to the ability to prevent a collapsing financial firm from bringing down the broader economy.
But the CHOICE Act goes still further, splitting the Federal Reserve in half and preventing it from coordinating financial regulations and monetary policy, something that will make bubbles more likely — and more dangerous to the economy. It would reduce the deference given to regulatory agencies, making regulations harder to pass, and harder to interpret. Republicans did not seek any Democrat input on the bill, and as such it’s unlikely to gain the support it needs to overcome a filibuster. Bloomberg’s Matt Levine called the bill “a kitchen sink of grievances.”
Yet there’s a way around the filibuster — one that will be familiar to those who have closely followed the health care debate. For years, conservatives in Congress have been eyeing the pieces of Dodd-Frank that can be repealed through budget reconciliation, a process that only requires a simple majority vote in the Senate (if the changes follow a complicated set of rules related to spending). This poses the biggest danger to financial reform in the next year.
Where financial regulations are concerned, Republicans’ top targets may surprise you. Many knowledgeable observers, such as Ben Bernanke, point to the ability of the Federal Deposit Insurance Corporation (FDIC) to take over and wind-down a financial firm on the eve of collapse — an ability created by Dodd-Frank — as a signal achievement of financial reform. Such powers would have prevented Lehman Brothers from going into bankruptcy in an uncontrolled manner, as it did in 2008, and would have thereby taken significant stress off the financial system. Yet these powers are in the crosshairs.
Many also argue that the risks of lending and borrowing among investment banks in the capital markets — so-called “shadow banking” — carry the potential to produce panics, runs, and other crises. Regulators have made progress in limiting such risks. Yet Republicans want to bring this kind of oversight to a halt.
Republicans love to hate the Consumer Financial Protection Bureau
The biggest target of all, however, is likely to be the Consumer Financial Protection Bureau, which was created to ensure that consumers have a dedicated financial regulator on their side. In its short life, the CFPB has been a remarkable success. It was essential in extracting a $100 million settlement from Wells Fargo for creating fake accounts for its customers that they did not want, then charging them fees for those accounts. It has provided billions of dollars in relief through legal actions against companies that used deceptive practices to sell financial products.
Perhaps most importantly, the bureau has brought transparency and accountability to previously opaque markets like consumer credit reporting, making clear just how much putting that new computer on your credit card will cost you in the long run. It has clarified for consumers the fine print aggressively wielded by nonbank debt collectors, mortgage and student debt servicers, and for-profit colleges. These are markets where consumers are often not in a position to rectify injustices themselves.
Conservatives have argued, however, that the CFPB is unaccountable and out-of-control — that it lacks any of the administrative checks that accompany other regulatory agencies. Rep. Jeb Hensarling (R-TX), chair of the House Financial Services Committee, has called it the “most powerful and least accountable” agency in American history. That’s the same exact wording used by Mitt Romney while running for President in in 2012.
But this supposed unaccountability is a canard. The CFPB is structured exactly like the Office of the Comptroller of the Currency (OCC), another banking regulator — one that the CFPB is designed to complement and counterbalance. Like the Comptroller of the Currency, the CFPB has a single director, a dedicated funding stream, and a clear mission.
The similarity between the two regulatory agencies is no accident. (Indeed, the Senate Report on the Dodd-Frank Act says the CFPB’s policies and “provisions are modeled on similar statutes governing the Office of the Comptroller.”) In the run-up to the financial crisis, the OCC and other federal regulators put bank profitability over safeguards for consumers. The CFPB wields a similar level of powers but has a mandate to fight for consumers.
It was unclear whether President Trump would fire CFPB Director Richard Cordray upon taking office. The legal case to do so was nonexistent, though many prominent Republicans encouraged him to. For now, Cordray has his job, which is set to naturally end in July of 2018, though the CFPB is still a target. We can expect Republicans to use reconciliation to dramatically reduce the budget, and by extension the effectiveness, of the CFPB.
A move to keep “shadow banking” in the shadows
The next target for Republicans will be the mechanism we have for dealing with risks posed by the overall financial sector. One of the lessons of the financial crisis is that it’s possible for the risks associated with traditional banking — panics, bank runs, and cascading failures of institutions — to be present in activities and institutions that aren’t traditional banks.
In the aftermath of Lehman Brothers’ collapse, investors in money market mutual funds, for instance, began rapidly pulling their funds. Soon, money market funds with no known Lehman exposure were having panics; in one week, investors in such funds withdrew $349 billion. This was the beginning of an It’s a Wonderful Life style banking run, but one that was in the capital markets of Wall Street instead of your neighborhood bank.
Rapid deregulation had led to a situation in which large commercial banks like Citigroup had investment banking subsidiaries within them that were poorly regulated relative to traditional banking. Dodd-Frank has fought for a consistent and clear regulatory regime for this type of credit creation. Republicans, however, don’t share this goal: The American Enterprise Institute recently ran a headline flatly stating “Shadow banks are not a source of systemic risk.” Republicans plan on instituting light-to-nonexistent regulation reflecting that assumption.
The way Republicans plan on achieving this dubious goal is by reducing the funding for the Financial Stability Oversight Council (FSOC), a council of regulators whose job is to monitor the financial system, while also slashing the budget of the newly created Office for Financial Research (OFR). The Financial Stability Oversight Council requires financial firms that pose an unusually high risk of collapse, panic, and uncertainty to the economy to follow tougher regulations — including straightforward regulations followed by regular commercial banks. Republicans will also weaken the FSOC by appointing people to the council who share the ideology that there are no special risks in this sector.
This upcoming attack is unfortunate because, as Amias Gerety, former Treasury assistant secretary for Financial Institutions under President Obama, describes in a recent paper, there’s been significant progress in reducing systemic banking risks. Bets that were hidden off the balance sheet of major financial firms have been put back on the books, making them clearer to investors and forcing banks to fund themselves with enough capital to handle the attendant risks.
New capital requirements require firms to have enough liquid funds to survive a crisis and make required payments to other firms. The riskier money market funds have been reorganized so they now have a value that fluctuates, which reduces the incentives for investors to be the first out the door like they did after Lehman failed. (Before, investors tended to bolt when money market funds “broke the buck” — when the share of a fund purchased per dollar dipped below $1. The new system makes it clearer that such funds, which tend to have low risk and low returns, aren’t guarantees.)
However, by going after the funding of the regulators designed to handle future risks in capital markets, progress could be stopped dead.
Some institutions are indeed “too big to fail.” But that doesn’t fit GOP ideology.
Republicans will also try to use budget reconciliation to kill the funding and emergency powers given to the FDIC to deal with a failing financial institution, should the Lehman Brothers scenario recur. One reason is that many influential Republicans think, once again, that there’s simply no systemic problem that needs fixing. When Financial Services Committee Chair Jeb Hensarling introduced his CHOICE Act to roll back Dodd-Frank, he answered a question about the “too big to fail” issue by saying that letting big banks fail, as the government did in the case of Lehman, posed no problems: “Although it was painful, and somewhat chaotic, in many respects, those in the bankruptcy arena would tell you, the Lehman bankruptcy, to some extent, worked as it should have worked.”
But there are good reasons why we shouldn’t simply let financial institutions like Lehman Brothers go bankrupt, especially during a crisis. Bankruptcy is slow while a financial crisis is quick. Bankruptcy isn’t designed to stop financial runs or keep operations running, and it is certainly not designed to quickly coordinate across the vast complexity of financial firms that exist in dozens of countries.
Access to a secure line of funding is necessary to keep crucial banking functions running — and that can be difficult to secure during a bankruptcy, especially if the financial markets are chaotic. A random bankruptcy judge won’t have any experience with the financial firm in advance. What’s more, both the bankruptcy judge and Congress will face huge political pressure to resort to bailouts to prevent a crisis.
To handle this, Dodd-Frank provides the FDIC with a special power to take over and gradually shutter financial firms in case of emergencies.
It’s called Orderly Liquidation Authority (OLA), which oversees what Barney Frank calls “death panels for banks.” Such liquidations are designed to function in some ways like bankruptcies, but they’re executed by regulators, who will have great familiarity with the industry and the firm. They can be done on the eve of a failure, which prevents managers from gambling to try to fix themselves — creating new problems that put the financial system at risk.
The FDIC can adjudicate claims quickly under this receivership, including putting a hold on derivatives and other complicated financial instruments. It can create a bridge company that allows for the transfer important entities to a new company. By targeting the parent company of a financial firm’s structure and forcing it to prepare for failure in advance, it can handle international scale and complex scope of financial institutions in a way bankruptcy cannot.
The liquidation authority has a dedicated funding stream that allows the FDIC to borrow against the failing firm's assets in a time of crisis. Though taxpayer money is always recovered first by statute, the CBO scored this power as having a budgetary cost. This score is controversial because CBO assumed money would be lent within the 10-year period but not recovered until afterward. Thus, under the complex reconciliation rules, Republicans can change and perhaps remove this power.
Dodd-Frank can be weakened through neglect, and the regulators President Trump puts into place are certainly likely to try that strategy. But the main danger is funding. Paul Ryan’s goal in the next two years is to recreate the federal government using a narrow majority and Senate budget rules to dodge the filibuster. This approach is dangerous when it comes to financial reform, because instead of creating a system that works for the overall economy, the proposals may well amount to a smash-and-grab of whatever fits this procedural trick.
Rapid change is the strength of this approach, but it would be rapid change in a direction that hurts consumers — and it makes a repeat of the 2007 to 2008 financial meltdown more likely.
Mike Konczal is a fellow with the Roosevelt Institute, where he works on financial reform, unemployment, inequality, and a progressive vision of the economy. He blogs at Rortybomb, and his Twitter handle is @rortybomb.
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