The 411 on 401: Keep 911 on Hold (Nov. 17)

Update 226: The 411 on 401; Keep 911 on Hold

A Problematic Provision in Senate Banking Bill

Today, the Senate Banking Committee released the bill text of its bipartisan proposal to reduce banking regulations. We drill down on a risky and perhaps politically damaging provision, Section 401, which rolls back systemic risk rules for 25 regional banks — deregulating a total of $3.5 trillion in consolidated assets of firms in question.

Nine Democrats immediately signed on to supporting this proposal. What is the sentiment of the majority of the caucus? Will the caucus leadership have to resolve the conflict?  Which GOP member of Senate Banking is unconvinced we need Section 401?  Read on.

Good weekends all,



Drafting Privately — A Significant Risk

In a surprising move, moderate Democrats on the Senate Banking Committee reached an agreement with Chair Crapo to provide regulatory relief to small and regional banks.  Ten Democratic Senators support this legislation. These range from red state committee members, such as Senators Heitkamp and Donnelly, to former Vice Presidential nominee Tim Kaine.

Most significantly, the deal quintuples the asset threshold for prudential standards from $50 billion to $250 billion. However, the Fed delays relief for banks over $100 billion from enhanced prudential standards under the following guidelines. The Fed:
* Will lift the threshold after an 18-month delay,
* Has the authority to re-apply standards to banks as it sees fit,
* May conduct periodic stress testing, and
* Has discretion to exempt banks from the 18-month delay.

Supportive Senators may live to regret this decision. Huge banks with household names are not the only systemically impactful institutions on the financial landscape. In 2008, Indymac, a bank with only $32 billion in assets, required FDIC conservatorship in order to be wound down without causing significant systemic harm. Not all smaller-sized banks are harmless.

Wall Street’s Number One Wish

Lobbyists and trade associations like the American Bankers Association will cheer if their investment of time and money in reducing financial regulations pays off. While many of the bill’s provisions cater to small banking interests, the five-fold increase of the $50 billion threshold for enhanced prudential standards will undoubtedly benefit Wall Street. Republicans have long wanted to drain the Dodd Frank Act of its regulatory impact. With moderate Democrats on board, this legislation has a real chance to increase systemic risk in the American financial system.

Systemic Impact

Three enhanced prudential standards would be lifted for 25 regional banks, which together total $3.5 trillion of industry assets. Without the $50 billion asset threshold, what is the alternative for determining which banks pose systemic risk?

CCAR: We believe this legislation would reduce the number of firms subject to CCAR from 34 to 9 at a minimum. Section 401 might also give regulators the option of eliminating the test entirely.  The stress test has had a measurable impact on regional banks’ health. Banks have performed increasingly well on the CCAR review since it became a yearly Fed practice. If the Fed loses the ability to fail a bank for its capital plans, banks will no longer be incentivized to prepare for times of extreme financial stress.

MLCR: Relieving regional banks of the requirement to hold a certain amount of High-Quality Liquid Assets weakens the ability of firms to convert assets to cash in times of crisis. With the liquidity coverage ratio, banks are restricted from lending out the short term debt that was a source of instability during the financial crisis.

Living Wills: Resolution plans require firms to plan their own liquidation so the financial system is not beholden to the insecurity of the bankruptcy process. Lifting this provision undoes a critical accountability measure that makes failure less systemically risky.

How Important are the Senate Banking Mods?

Theirs are the most valuable votes of all. Although the Dodd-Frank Act’s regulations were aimed at Wall Street, Democrats and Republicans agree that unnecessary regulations have trickled down to Main Street.  The unintended consequences have negatively impacted community banks, and the financial sector has been leaning on lawmakers to enact reform.  For regional banks, Republicans seek regulatory “tailoring” to replace what they call “arbitrary” asset thresholds.

Corker’s Take

Senator Corker, who recently told the New York Times that he expects aspects of Dodd-Frank to “stand the test of time,” has a particularly interesting perspective on the expanded thresholds. Corker reportedly feels that there is insufficient reason to raise the threshold of advanced prudential standards because these standards are not particularly onerous for financial institutions.

This is not to say that he will vote against the bill simply because of section 401. It is unlikely he feels that raising the threshold would be unacceptably dangerous for the economy. Given that the bill already has nine Republican co-sponsors, will Corker to get in line with his colleagues on the committee and vote for this legislation?

Banking Committee Dynamics

After regulatory reform negotiations between Senators Crapo and Brown broke down earlier this month, moderate Democrats quickly turned to Republican leadership to strike a deal. Several of the Democratic cosponsors face tough 2018 reelection campaigns in states that Trump carried in last year’s general election. These Senators feel they had to deliver this legislation to help their electoral chances, and they were able to secure regulatory relief for small banks that operate in their respective states. Ranking Member Brown wasted no time registering his dissent, and for good reason — this deal undermines him on a committee is supposed to be leading.

Consequences for the Democratic Caucus

Senator Brown did not mince words when rejecting the compromise, saying that, ”the wisdom of rolling back so many of Dodd-Frank’s protections with almost no gains for working families.” Senator Warren also opposes the moderate Democrats’ compromise, and as a leader of the progressive wing heavily interested in banking regulation, her disapproval may ignite tensions within the party.

Schumer’s Decision

Party unity is Senator Schumer’s to navigate. He is now faced with a few unsavory options:
1. Support the Moderates and push for the bill to be included in a December spending bill;
2. Allow the bill to be fought over on the floor and pass anyways;
3. Stand with the Ranking Member and Progressive wing in opposition to the bill and lose.

The first option keeps this conflict as quiet as possible, but it also takes the opportunity to attack the GOP for giving in to Wall Street. Allowing a floor fight would create that opening, but would also risk the progressive wing slamming the bill and moderate supporters getting caught in the crossfire. The last option would mirror Brown’s attempts to stand strong in the committee negotiations, but would likely to end similarly in failure. It is hard to imagine the minority leader choosing to fight a battle he can’t win.

Next Steps

With no perfect options, leadership faces a tough choice. While this bill does some damage to Dodd Frank, another dangerous factor to consider is that this may set a deregulatory precedent, emboldening Wall Street’s lobbyists and legislators to go further. Schumer will need to unify his party behind the message that the most Democrats will tolerate, and push for fixes to this bill’s most dangerous provisions.

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