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The U.S. financial regulatory framework has become increasingly wasteful and unproductive, and not simply because Congress passed the 2010 Dodd-Frank Act. There was a clear long-term trend long before the 2008 financial crisis, the calamity that inspired Dodd-Frank.
Three otherwise unrelated events from the previous month demonstrate that the United States remains on this wasteful long-term path.
The first is the May release of a Brookings paper by Daniel Tarullo, the chief regulator at the Fed from 2009 to 2017. The paper is titled Reconsidering the Regulatory Uses of Stress Testing, and it argues that, ideally, regulators would employ a more dynamic stress testing regime that is linked directly to large banks’ capital requirements.
According to Tarullo, this is the sort of framework that he and his fellow Fed bureaucrats thought they were setting up in the early years of stress testing. Although he still thinks this approach would be ideal, he says that “It is difficult to say just how useful the stress test results have been for these different groups [regulators, banks, and markets].”
He also acknowledges that “there is no necessary link between stress testing and other regulatory aims,” and notes that “More stringent capital requirements for large banks can be implemented solely through adding surcharges.” Of course, they don’t even have to be implemented through surcharges, but I digress.
The second event is a speech by Federal Reserve Board Governor Michelle Bowman, delivered June 17 in Austria. The speech stressed the importance of creating a financial regulatory environment that “fosters successful innovation,” rather than one that reflexively stops it.
Bowman deserves credit for acknowledging that when bank regulators try to stop innovation, it only drives more financial activity outside the banking sector.
But the speech shows Congress has created a system that relies more on the supposed expertise of regulators to “manage risks” than on market participants to be careful with their investments. This problem is massive, and it produces a false sense of security. It comes from everything from federal backing (implicit and explicit) to intricately detailed rules and regulations.
Over time, this system was erected to keep financial markets safe and stable, but it’s never really worked. Yet we keep right on expanding the ability of regulators to dictate what banks can do and how they can do it. It should surprise no one that things still go wrong no matter how many boxes the banks must check.
The third event occurred June 21, when the Federal Deposit Insurance Corporation and the Fed released their resolution plan reviews. That’s where they assess the eight largest banks’ plans for a “rapid and orderly resolution” in the event they were to fail. Four of the banks made the grade, but the regulators identified weakness in the plans from Bank of America, Citigroup, Goldman Sachs, and JPMorgan Chase.
In each case, the supposed weakness deals with the banks’ ability to model the unwinding of derivatives and trading positions if they were to fail. In other words, the regulators are not satisfied with the banks’ projections of how they might sell off their derivatives in the event of failure or major financial stress. (It’s all hypothetical, of course.)
Maybe this whole exercise seems comforting, but it’s just another example of how pointless our financial regulatory system has become. It’s one thing to require the largest banks to have a resolution plan, it’s another thing to pretend that anyone can possibly know every detail of how that resolution might unfold.
The regulatory agencies and the banks’ lawyers continue to waste millions of dollars, pretending that they’re doing something useful and keeping the financial system safe. All the while, regulators have enormous discretion to change course on any of these items whenever they like. And the regulations are so voluminous and complex that the regulators are perpetually tied to the banks and in a superior position to Congress.
Many people pretend this system remains true to the tenants of self-government set out in the U.S. Constitution, and true to the principles of free enterprise. But the best that can be said about this regulatory regime is that the regulators usually work for someone appointed by a president and confirmed by the senate.
It’s very hard to blame the cynic for thinking that Congress has abandoned its responsibility.
Regardless, few Americans understand how the regulatory process even works, much less what the regulations accomplish. And who can blame them? Most people have no incentive to pay attention even to what their banks are doing, so it’s ludicrous to think people regularly hold elected officials accountable for whether regulations are effective.
Combined, these problems only feed the slow death of free enterprise and freedom.
For decades, the regulatory regime has prevented bankers from competing and innovating based on besting their competition. It forces bankers to go to the regulators for approval of how to innovate and compete.
This arrangement is backwards. No federal regulator should be in the business of having to foster innovation—that should be up to the banks.
Both our government and our businesses are more accountable when fewer people have less power over others. The best way to ensure that Americans can hold officials accountable is to limit the reach of government, so that people can effectively monitor what those officials are doing.
