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Time for a Post-Financial Crisis Review

During the presidential campaign, Donald Trump vowed to “dismantle” the Dodd-Frank Act and increase bank lending, but provided few specifics as to how he would do so. A new executive order provides a better sense of where the White House intends to go on financial regulation. The order’s goals could build on post-crisis reforms if policymakers use those goals as the basis for an empirical review of how those reforms are actually working.

Both Republicans and Democrats are likely to agree with the seven “core principles” outlined in the executive order, most of which are fairly non-controversial. The disagreements will be more on how to meet these goals and whether current policy is already doing so.

Major policy changes, like the ones implemented after the financial crisis, never go entirely as planned.

The order’s seven core principles lay out how the administration intends to regulate the U.S. financial system. It then directs the secretary of the Treasury, in consultation with the heads of the financial regulatory agencies that are members of the Financial Stability Oversight Council (FSOC), to report to the president within 120 days on how existing laws and policies promote or inhibit the core principles:

  • Empower Americans to make independent financial decisions and informed choices in the marketplace, save for retirement, and build individual wealth
  • Prevent taxpayer-funded bailouts
  • Foster economic growth and vibrant financial markets through more rigorous regulatory impact analysis that addresses systemic risk and market failures, such as moral hazard and information asymmetry
  • Enable American companies to be competitive with foreign firms in domestic and foreign markets
  • Advance American interests in international financial regulatory negotiations and meetings
  • Make regulation efficient, effective, and appropriately tailored
  • Restore public accountability within federal financial regulatory agencies and rationalize the federal financial regulatory framework

The Need for an Independent Review of Post-Crisis Changes

Major policy changes, such as the ones implemented after the financial crisis?never go entirely as planned. BPC’s September 2016 paper, Did Policymakers Get Post-Crisis Financial Regulation Right? argued that Dodd-Frank and other post-crisis reforms made the financial system safer and better protected consumers from risky financial products, but there are also cases where reforms are not working as expected and producing unintended consequences. These include:

  • A lack of coordination, and unnecessary duplication and conflict in rules
  • The migration of certain activities from banks to nonbanks or across borders, and the curtailment of other activities
  • The existence of binding constraints on the business decisions of firms, sometimes resulting in “cliff effects” in which the provision of financial services or products to certain consumers and businesses experiences a sudden and steep reduction due to one or more regulations rather than competitive market factors

These are areas that should be studied and addressed. As a model, U.S. policymakers should look at the European Commission’s call for evidence on the impact of financial rules and regulations on the European economy, and whether there are unnecessary regulatory burdens, inconsistencies, gaps, or unintended consequences.

The administration should broaden its effort to request public comments on the core principles and regulatory environment. Further, Congress should create an independent commission to conduct the first in a series of periodic, formal assessments of the effects of the financial regulatory system on financial stability, consumers, and economic growth.

How the Core Principles Could Lead to Better Policy

As mentioned earlier, most of the core principles in the order are non-controversial. The debate will be in how they are approached. Here are three examples of how a regulatory review could improve oversight of the financial system.

Preventing Bailouts

Take the core principle to “prevent taxpayer-funded bailouts,” a goal no one would disagree with. Dodd-Frank made strides in this area by giving regulators new tools to let large, complex financial institutions fail without disrupting the broader financial system. More could be done, however, including adding a new chapter to the Bankruptcy Code specially designed for financial institutions. But given how unpredictable and fast-moving financial crises are, having a backstop in place for the government to step in during a “break the glass” moment is also important.

Rationalizing the Regulatory Structure

Perhaps the main missed opportunity of Dodd-Frank was in not fixing the United States’ fragmented regulatory structure. There is visual evidence of this fragmentation at any FSOC meeting, which includes 10 voting members and 5 non-voting members, several of which have overlapping or duplicative functions. Both former Senator Chris Dodd and former Congressman Barney Frank have said they would have done more to streamline the regulatory structure had the votes been there to do so.

The executive order, in calling to “rationalize the federal financial regulatory framework,” is an opportunity for Congress to get it right. A better approach would look something like what BPC outlined in its paper, Dodd-Frank’s Missed Opportunity: A Road Map for a More Effective Regulatory Architecture, including:

  • Creating a new Prudential Regulatory Authority to consolidate federal bank prudential supervision and regulation in a single agency. In the interim, Congress should set up a pilot program for a consolidated examiner force that would coordinate the bank exams of federal bank supervisory agencies
  • Creating a single, modern Capital Markets Authority to consolidate oversight of the fair and efficient functioning and competitiveness of U.S. capital markets
  • Giving FSOC the authority to focus its efforts on risky activities and products rather than designation of individual nonbank financial institutions as “systemically important”
  • Making FSOC more transparent and accountable
  • Granting all financial regulatory agencies independent funding to appropriately insulate them from political influence, while maintaining accountability through reports and testimony to Congress, separate inspectors general for each agency, and appropriate transparency

The executive order, in calling to “rationalize the federal financial regulatory framework,” is an opportunity for Congress to get it right.

Global Coordination

Another example is the principle to “advance American interests in international financial regulatory negotiations and meetings.” Global coordination on financial regulation is generally positive. For example, it is beneficial to work with other countries to prepare for the resolution of large, globally active financial firms to make failure more orderly and minimize disruption to customers and markets.

There are other areas, however, where the U.S. approach to financial market and oversight, such as on accounting standards, remains apart from that of other countries. Insurance regulation is an area in which differences are significant. In formulating its initial proposal for insurance capital standards, Federal Reserve Board Governor Daniel Tarullo noted several areas in which the European approach to insurance regulation was not a good fit for the United States to adopt.

In general, the United States should pursue global coordination, but there will be cases where other considerations take precedence.

Where to Go from Here

President Trump’s executive order provides a basis for improvements to financial regulation if it is approached with a focus on evidence over ideology. The order directs Treasury and FSOC to develop a report, which is a good first step. A call for evidence similar to the one issued by the European Commission that was open to public comment would be better still. And Congress would be well-served to create an independent commission to study the impacts of financial regulation on financial stability, the economy, and consumers, and to do so on a regular basis.

In the months ahead, BPC will be taking a deeper look at the impacts of the post-crisis regulatory structure.

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