February 17, 2015

Too Big to Fail vs. Too Little to Lobby

Dodd-Frank merely expanded the policy it claimed it would end.

It’s a bad day when the Harvard Kennedy School for Business and Government labels your policy a failure and blames it for actually exacerbating a situation. A new study shows the 2010 financial reform law known as the Dodd-Frank Wall Street Reform and Consumer Protection Act simply made “too big to fail” even bigger and increased the likelihood of greater risk and bailouts.

The paradoxes of bad policy are legend. We’re still living through the “Affordable Care Act” that was supposed to drive health costs down but is instead costing more for everyone. Even the dietary practices meant to eliminate fat consumption are the very reason we’re getting larger.

Likewise, the sweeping law that was supposed to “reform” America’s financial institutions after the 2008 financial panic is proving its critics accurate.

First, named after two of its now-retired proponents, Senator Chris Dodd of Connecticut and Congressman Barney Frank of Massachusetts, the law was clearly established on statist principles – the government knows best.

Second, with a grandiose purpose that’s so broad it lacks only the cure to Ebola, the expanse ensured collapse under its own weight. The law’s preamble laid out its lofty goals: “To promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail’, to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.”

Third, this legislative web came in response to the “Great Recession.” But bad government policies induced the risky behavior in the first place, and beefing up those policies was clearly the wrong solution.

Remember, the most basic goal of Dodd-Frank was to prevent the increasingly prevalent consolidation of banks and lending institutions. However, the Harvard study aggregates hard data demonstrating the destructive effects of these new regulations on small community banks, which were eaten alive by compliance costs that followed a new mountain of regulations. “[Larger] banks are better suited to handle heightened regulatory burdens than are smaller banks,” the study notes, “causing the average costs of community banks to be higher.”

That resulted in many more community banks being swallowed by large ones.

Forbes writer Carrie Sheffield explains, “[T]he number of community banks fell by 40 percent since 1994, and their share of U.S. banking assets fell by more than half – from 41 percent to 18 percent. In contrast, the biggest banks saw their share of assets rise from 18 percent to 46 percent. And while the number of community banks had already declined before the crisis, since the second quarter of 2010 – Dodd-Frank’s passage – community banks have lost market share at a rate double what they did between Q2 2006 and Q2 2010: 12 percent vs. 6 percent.”

Study authors Marshall Lux and Robert Greene combed through Federal Deposit Insurance Corporation (FDIC) data to observe, “Community banks service a disproportionately large amount of key segments of the U.S. commercial bank lending market – specifically, agricultural, residential mortgage, and small business loans.”

Despite a 50% decline in total banking assets over the last two decades, community lenders provide 77% of agricultural loans and over 50% of small business loans. These smaller institutions serve as the lifeline of the working-man’s industry.

These smaller banks are critical to farmers, for example, thanks to their ability to personalize loans to fit longer agricultural cycles and weather uncertainties. Larger banks more often reject lending applications or offer stiffer terms.

On the real estate front, the default rate in 2013 for borrowers securing loans for a family residence through a community bank was 3.47%, while larger banks owned a default rate of 10.42%. Those local relationships pay off in the area of accountability.

With the burden of regulation came the hefty price tag. Who’s paying it?

The middle-class consumer is, through reduced bank services and increased fees.

The data is extensive and conclusive: Dodd-Frank is a bad law and should be repealed. The GOP-led legislative branch is moving to “chip away” at the choking regulations. But will the changes benefit the too-big-to-fail banks or work to assist the too-little-to-lobby?

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