The regulatory wave that has swept the developed world since the 2008 financial crisis may finally be cresting. Recent developments suggest a new recognition by voters and governments that excessive regulation is responsible for the slow economic growth of the past eight years. If so, this is good news. The bad news is that U.S. regulators may not have gotten the message.
Any discussion of this issue must begin with Brexit, a populist revolt against the administrative state that the European Union has become. With their divorce from the European Union, the people of Britain will be able to set their own course on trade, regulation and taxation, freeing that resourceful country to compete for investment. If the 2010 Dodd-Frank Act remains in force in the U.S., London could be the center of world finance within five years.
Even leaders of the G-20-the world’s most economically developed countries-have begun to register concern about excessive regulation. In 2009 the G-20 deputized the Financial Stability Board, a largely European organization of central banks and financial regulators, to develop a comprehensive global system of financial regulation.
The U.S. Treasury and the Federal Reserve are members and endorsed its actions with enthusiasm, pushing to implement its directives through the U.S. Financial Stability Oversight Council. Shortly after receiving its mandate, the Financial Stability Board designated 39 banks and nine insurance companies as “global systemically important financial institutions” or G-SIFIs. This included three U.S. insurers- AIG, Prudential and MetLife -which the Financial Stability Oversight Council then dutifully designated as SIFIs in the U.S.
But in this year’s G-20 meeting in China, the leaders clearly expressed reservations about the mandate they had given the Financial Stability Board. Although they have routinely endorsed the board’s regulatory program, this year the G-20 leaders added a significant coda, promising “to address any material unintended consequences” of the board’s proposals. The concern shows that political leaders have finally come to see the trade-off between regulation and economic growth.
This same trade-off was front and center in the EU’s recent decision not to implement the latest Basel-developed bank capital regulations. This was another rebuke to the Financial Stability Board, which has been coordinating its regulatory agenda with the Basel Committee on Bank Supervision. It was a particular setback to the Fed, which has been the principal advocate for tougher bank capital and liquidity rules. The EU’s decision was based squarely on its fear that capital requirements for the largest banks were already high enough and that unnecessary increases would further stifle the EU’s economic growth. Then in September the House Financial Services Committee adopted legislation to repeal the most troubling elements of Dodd-Frank. The key provision-from chairman Jeb Hensarling-would allow banks to escape the heaviest regulation by forgoing Basel risk-based capital rules and meeting a simple tangible equity leverage test. The bill as a whole was strongly supported by the community bankers, whose enormous and unnecessary Dodd-Frank-induced compliance costs have impaired their ability to lend to start-ups and small businesses throughout the U.S.
The committee’s Democrats made no effort to amend the legislation or force votes on specific provisions, suggesting that they saw little political benefit before the election in opposing this and other Dodd-Frank reforms.
Running counter to these trends, however, was a September report by U.S. bank regulators recommending that Congress repeal provisions of the 1999 Gramm-Leach-Bliley law. These provisions permitted bank holding companies-firms that control banks-to engage in merchant banking by taking non-controlling equity positions in non-financial companies. This is a backdoor reinstatement of the 1933 Glass-Steagall Act, which separated commercial and investment banking. It would again isolate banks from the financial system’s mainstream.
Since the mid-1980s, the securities markets have out-competed banks in financing American business, and year by year the gap has grown wider. There is nothing that can be done about this. It is simply less expensive for companies registered with the SEC-which means most large companies-to finance themselves through issuing bonds, notes and commercial paper to private investors instead of borrowing from banks.
By 1999 Congress had recognized that banks could not survive as financial intermediaries unless they could also participate in the growing securities markets. Because banks’ deposits are government-insured, Congress did not want them to compete with broker-dealers in underwriting or dealing in securities. But there was a viable compromise: Bank holding companies-not the insured banks themselves-would be permitted to own investment or merchant banks. Since the adoption of this law, these activities have become one of the most profitable businesses of bank holding companies, giving them the financial strength to support their subsidiary banks.
Rescinding this authority would again place the health of the banking system at risk, just as ill-conceived regulation in the 20th century almost destroyed the U.S. railroads. The regulators’ theory is that merchant banking is risky. This is doubtful, but even if it were true the risks are being taken by companies that own banks, not by the government-insured banks. If one of those holding companies should fail, it will have no effect on subsidiary banks as long as they are well capitalized. The bank regulators should focus on assuring adequate capitalization, not trying to control the activities of non-bank affiliates.
There is solid evidence that excessive regulation since the financial crisis has kept the U.S. and other developed economies from growing faster. The political process world-wide has begun to take notice. U.S. regulators should too.