Why Dodd-Frank Is Regulatory Overkill

"Those who argue that housing prices are now at the point of a bubble seem to me to be missing a very important point … We are talking about an entity, homeownership, homes, where there is not the degree of leverage that we've seen elsewhere. This is not the dot-com situation … You're not going to see the collapse that you see when people are talking about a bubble."

— Rep. Barney Frank on the floor of the House of Representatives,
June 27, 2005

As a newbie to American Banker and a Washington outsider, I headed to our Regulatory Symposium in the nation's capital earlier this week in listening mode. In my four months at the Banker, I've often been struck by the way banking and regulatory types inside the Beltway talk of the Dodd-Frank Act as if it were as natural a part of the environment as the air and water. Terms that would befuddle the average MBA grad — CFPB, QRM, FSOC, SIFI, UDAP — roll off their tongues as if they've been with us since the days when banks printed their own currencies.

To me, a lot of it's still alphabet soup. That's probably helpful in understanding what this uniquely Washingtonian response to a crisis looks and feels like to the folks whose day jobs it is to run our nation's banks and parcel out its credit.

To bankers in the trenches, it hardly matters whether you take the Democratic view espoused by Sen. Jack Reed that Dodd-Frank is a thoughtful reaction to recent financial misdeeds or subscribe to the Republican notion that it's a leading culprit in our economic malaise

Bankers of all political stripes now face the prospect of complying with a law that will do everything from raise capital and liquidity standards to dictate how derivatives are traded to determine how much banks charge in debit card fees.

Dodd-Frank co-author Barney Frank argued his case forcefully at our conference. He adeptly got out ahead of critics by asserting that his creation was careful "not to put our business at a competitive disadvantage" internationally and sharply disputed a questioner for asserting that the law hurts community banks.

Raj Date, acting head of the Consumer Financial Protection Bureau, showed impressive poise in asserting that his organization will balance necessary consumer financial protections with the need to let market mechanisms exert most of the discipline the industry needs.

Taken in isolation, such arguments often sound eminently sensible. It's in the aggregate, in weighing benefits against costs and in pondering the unintended consequences, that Dodd-Frank starts to look like a threat to our financial system. At 2,319 pages, including 250 amendments, and with vastly more rulemaking to come, Dodd-Frank's costs are only now starting to mount.

Whether all this will make our financial system safer is an open question. Even Barney Frank would likely concede that the hugely expensive Sarbanes-Oxley Act of 2002, of which he is a fan, has not had the intended effect of wiping out corporate wrongdoing. What's not in dispute is that Dodd-Frank will impose a major drag on the business of commercial banking and have numerous knock-off effects that were neither intended nor necessarily desirable.

First the unintended consequences, which by definition are impossible to predict. Here are few early bloomers that came up at our conference:

Fewer and bigger banks: Because the legislation will be so costly to comply with, banks will have more incentive than ever to consolidate into the sort of too-big-to-fail banks the bill was designed to stamp out. "Dodd-Frank has raised the cost of financial transactions in America and that encourages consolidation because it's the only way you can spread the costs over larger assets," said Tom Hoenig, president of the Federal Reserve Bank of Kansas City.

Drawing lines in the sand: Under Dodd-Frank the Federal Reserve is charged with deciding whether mergers would create too-big-to-fail institutions. Capital One now faces the first such review. As editor at large Barbara Rehm wrote earlier this week, the Fed may feel compelled by approve Cap One's acquisition of ING's online operations precisely to avoid stranding even bigger banks in a no-man's land where any and all M&A is deemed unacceptable.

Higher consumer costs: With higher regulatory costs, including debit card fee caps imposed by government fiat, banks are hiking fees elsewhere. SunTrust and others are adding new annual fees, TD Bank has begun charging customers to use other banks' ATMs and U.S. Bank is increasing what it charges for paper statements, noted Friedman Billings Ramsey analyst Paul Miller. "It has become more expensive for consumers to use banks," added Elizabeth Robertson of Javelin Strategy & Research.

Fewer mortgages: With Dodd-Frank, negative press and pressure to buy back soured home loans, big banks are becoming increasingly inclined to pull out of the mortgage business, Miller added.

Tighter trade credit: One largely overlooked Dodd-Frank provision will require banks to comply with new liquidity, as well as capital, standards. That includes backup liquidity lines. "This could have a negative effect on the ability [of banks] to extend trade credit and have a critical impact on our economy," said Reginald Imamura, an executive vice president at PNC Bank.

What all this will cost is impossible to say. Robert Wilmers, chief executive of M&T Bank, said the added paperwork is already requiring 18 full-time employees. One capital adequacy calculation that an analyst formerly could complete in a few hours now requires vastly more time, including 60 inputs, 20 mathematical calculations and for the result to be divided by 42.735. It reminds me of a U.S. tax code that's gotten ever more costly, complex and dysfunctional without necessarily adding any value.

Such financial drags will ultimately translate into banks charging higher rates on loans to recoup their costs, adding more fees or reporting lower profits to investors. Any way you slice it, someone is going to pick up the tab in a very tangible way.

All this leads to the ultimate absurdity of Dodd-Frank that seems so obvious from outside the Beltway: It's a fool's mission for our government to try to micro-manage our financial system — and for all the lip-service paid to balancing regulation and markets, that's precisely what Dodd-Frank purports to do.

Ill-conceived as it is, Dodd-Frank is destined to fail in its main mission of preventing the next financial crisis. Adding insult in the eyes of critics like Wilmers is the fact that the law doesn't even try to address what many regard as key culprits in the financial crisis — the roles of Fannie Mae and Freddie Mac, the credit ratings agencies and the fact that our financial system is more consolidated than ever in the hands of a few too-big-to-fail banks.

"We need to be very careful in how much we rely on government to see what markets can't," says Hoenig with his Midwestern perspective. Anyone who's tempted to think big government knows better need only consider that in 2005 Barney Frank was just as certain there was no housing bubble as he is today in the wisdom of Dodd-Frank.