On the fifth anniversary of Dodd Frank, former Sen. Christopher Dodd and former Rep. Barney Frank are patting themselves on the back. When asked about the best part, Frank speaks about the bill as though it were his own child and says the best change created by the law was to “substantially diminish the number of loans.”
Frank is referring to loans that he thinks should not have been made, but nowhere does he mention the legislation prevents many legitimate borrowers from getting loans. And nowhere does he or Dodd mention the billions of dollars of regulatory compliance that their regulation has required.
They completely ignore the cost of the 22,296 pages that their regulation has to the Federal Register or the 819,094 required comments to a mishmash of regulatory agencies including the CFTC, SEC, FDIC, Fed and CFPB. Victor Frankenstein may have had good intentions, too, but he created a monster. The same is true of Dodd Frank.
Dodd Frank harms many people, but it particularly harms smaller businesses and less privileged people. Among the major problems in the wake of Dodd Frank are the constant government fines and lawsuits. Even though borrower default rates are at record lows, the government is constantly prosecuting companies and extracting half-billion dollar fines from banks when even a small percentage of their loans default.
Regulators have shown themselves to be quite bad at differentiating between malfeasance and sensible business risks. This is particularly true in the mortgage market where most loans are good, but a small percentage inevitably ends badly.
A recent government lawsuit against Quicken Loans claims that the lender committed fraudulent acts like miscalculating a borrower’s income by a whole … gasp … $17. Rather than praising banks for enabling financial intermediation and the American dream, politicians, regulators and prosecutors view banks as villains or as sources of revenue through fines.
Another major problem with the Dodd Frank fallout is that it has turned questions previously about risk management into legal questions. Bankers can no longer assess risk based on what they think is prudent. Instead they check complicated boxes and file paperwork. For many Americans, the process of applying for a mortgage has become painful and overly burdensome.
When even Ben Bernanke cannot get a mortgage, what does that mean for the average person?
Dodd Frank regulations are pushing banks toward stellar borrowers and away from whole classes of deserving people. For example, J.P. Morgan has increased its jumbo loan (loans for mansions) business by 59 percent over the past year and is shifting its business away from helping lower-income borrowers..
Dodd Frank also gets in the way of banks taking good business risks. In the first quarter of 2015 the loan loss rate for many large banks was close to zero percent. That’s not a good thing. Regulators that do not tolerate risk-taking prevent many deserving, albeit slightly riskier, borrowers from getting loans.
Contrary to Dodd Frank, dealing with slightly riskier borrowers, including ones who are more likely to commit fraud, is not necessarily a bad thing when it can be priced into the cost of a loan. If a bank correctly estimates that out of a pool of 100 borrowers zero will default, there is no default risk premium for those borrowers. If a bank correctly estimates that out of another pool of 100 borrowers, one loan will default (including some due to fraud), it can simply price that default risk into a 1 percent higher interest rate.
That’s how risk management works: the riskier the loan, the higher the risk premium built into the interest rate. The advantage of such a setup is that it lets people who don’t have the most established financial history or who aren’t millionaires borrow money.
Yet regulations and lawsuits in the wake of Dodd Frank get in the way of good risk management and sensible risk taking. Many left-leaning advocacy groups have correctly point out that punishing banks for making loans that go bad disproportionately hurts the less privileged.
Default risks, including fraud, can and should be built into interest rates and government should not treat poor performance on any given loan like a crime. What would happen if the regulations were repealed and lawsuits against banks end? Who would pay for the cost of any bad loans? The simple solution is to let that bank or the investors who repurchase those loans pay, not taxpayers. That was how banking worked for hundreds, if not thousands, of years. Let’s permit banks to do their job of assessing risk and have them benefit or pay the cost of their decisions.
Dodd and Frank’s creation has already imposed billions of costs on the economy and that can easily become trillions if we look at decreased national income in the long run. Averse as I am to criticizing others’ children, Dodd and Frank’s child is not the wonder that they think; it is more like a monster. Although readers can have some sympathy for the death of the monster in Frankenstein, we should not feel the same sympathy about letting the Dodd Frank legislation expire.
