Update 183: Treas. Report Score: Mnuchin 1, Bannon 0 Systemic Risk Report Due in October
The administration’s first Treasury Report on financial regulatory policy was released last night and contained a few surprises. Instead of advocating a Bannonidtic dismantlement of the Dodd-Frank Act (DFA), it left many of the most important and controversial systemic risk components in place. The changes sought are not nearly as radical as those in the CHOICE Act, excepting changes to the CFPB.
And the Report is the most (or only) economic policy presentation, written or spoken, of in any depth and real policy coherent from the administration, which may be getting the benefit of the bigotry of low expectations here. Details below.
Scope of Proposals
The Report released yesterday purportedly focuses on one facet of the financial system: the depository system — including banks, saving associations, credit unions, and regulatory charters.
The next three reports will cover:
- Capital markets
- Asset management and insurance
- Non-bank financial institutions.
The Report does not cover OLA or the FSOC SIFI designation process, but promises to address these issues later. It addresses many of the less controversial pieces of the financial system, mostly tinkering with what could be called technical corrections but occasionally taking structural hammer to such DFA pillars such as the CFPB.
This Report was published pursuant to an Executive Order (EO) signed by President Trump on February 2. In the EO, Trump indicated his intent to recalibrate the financial system to reflect a set of core principles — preventing taxpayer-funded bailouts, making regulation efficient, effective, and appropriately tailored, and restoring public accountability within the Federal financial regulatory framework.
The general finding of the Report is that seven years after DFA, regulation is apparently insufficiently tailored to depository institutions based on the size and complexity of their business models. It asserts that the complicated oversight structure raises the cost of compliance, leading to the duplication of efforts for many of these institutions. Relatedly, there has been a slow rate of bank asset and loan growth due to DFA, but unclear is whether the administration considers this link causative or correlative.
- Systemic Risk
— Financial Stability Oversight Council (FSOC)
- Statutory mandate should be broadened
- Assign a lead regulator as primary regulator in issues where multiple agencies have overlapping jurisdiction
— Office of Financial Reform (OFR) becomes functional part of Treasury
— Stress-test rules for banks
- Amend $50 billion threshold under section 165 of DFA
- Narrow scope of LCR
- CCAR changed to two-year cycle
- For community banks, amend section 171 of DFA to exempt from capital rules
— Volcker Rule
- Exempt smaller institutions — those with $10 billion or less in assets whose failure would not pose risk to financial stability
- Focus on core business of lending to consumers
- Note: most smaller institutions are not doing proprietary trading so would have little to no effect
- Other Recommendations of Note
- Increase accountability (very poorly defined) of CFPB director
- Restructure CFPB as independent, multi-member commission or board to create an internal check on the exercise of agency power
- Subject to OMB appointment
- Fund through annual appropriations process to give Congress greater oversight and control
- Repeal the CFPB’s supervisory authority and leave that to the Fed and the OCC
- Repeal the application of section 1071 of DFA to small business lending because costly to implement requirements
— Community Reinvestment Act (CRA)
- Modernize the CRA statute
- Better align benefits of CRA investments with the interests/needs of the communities they serve
- Solicit inputs from stakeholders
Relative to the CHOICE Act, this report seems to appreciate parts of the DFA instead of aiming to eliminate all of it. In recommending that FSOC “play a larger role in the coordination and direction of regulatory and supervisory policies,” the administration appears to endorse an agency created by Dodd-Frank that House Republicans voted last week to abolish. This unexpected appreciation of DFA’s systemic provision is confirmed in the Report’s support for making OFR “a functional part of Treasury,” institutionalizing an office marked for extinction by House Republicans.
Almost all of this section of the Report’s policy recommendations is devoted to relief for banks subject to stress tests, including off-ramp provisions for the best performers.
Reasonable people can disagree about the efficacy of the living wills as a tool to assist in the resolution process, but industry and regulators have both expressed dissatisfaction with the process and outcome.
If consumer spending comprises close to 70 percent of U.S. economic growth, an agency that constrains rather than promotes consumer credit cannot be suborned.
In fact, on the spurious theory that the DFA consumer protections under the CFPB have constrained lending to consumers and are bad for community banks (who never were the subprime and alt-A culprits of the crisis)the Report recommends limiting the independence and authority of the Bureau.
The Report’s most specific and considered policy proposals offered are in the area of greatest political consensus on financial regulation: relief for the smaller banks and for credit unions.
The Senate Banking Committee and Senate GOP leadership understand passage of any package requires 60 votes — eight Democratic. Last week’s SBC hearing on fostering economic growth through reforms to community banking indicates the body’s interest in starting small. The panel will next hear witnesses on regional and mid-size banking issues Thursday.
Much of Treasury’s report aims to entice Democrats who face pressure to support community bank regulatory relief. The report points out community banks serve the needs of small businesses and rural communities — constituencies Democrats struggle with. Such banks account for 43 percent of small loans to small businesses and 90 percent of agricultural loans. Sens. Heitkamp, Tester, Donnelly, Manchin, and Warner could be the first Democrats to support Treasury’s recommendations in Senate form. The Senate has seen the introduction of the following bipartisan proposals:
- (S.567) The Federal Savings Association Charter Flexibility Act, bipartisan legislation sponsored by Senators Jerry Moran (R-KS) and Heidi Heitkamp (D-ND), would amend the Home Owners’ Loan Act to provide federal savings associations with the choice to operate as national banks.
- (S. 828) The measure introduced by Senators Mike Rounds (R SD) and Mark Warner (D-VA) would amend the Federal Deposit Insurance Act to allow banks to classify municipal debt as level 2B assets under the Liquidity Coverage Ratio.
- (S. 1139) Main Street Regulatory Fairness Act, introduced by Sens. Jon Tester (R-MT), Jerry Moran (R-KS), and Heidi Heitkamp (D-ND) would provide relief from Dodd-Frank Act stress tests, making them less frequent and increasing the asset threshold for such testing from $10 billion to $50 billion. The proposal found its way into Treasury’s report.
- (S. 1002) The Community Lending Enhancement and Regulatory Relief Act of 2017 (CLEAR Relief Act), introduced by Senators Moran (R-KS), Tester (D-MT), Heitkamp (D-ND) and Tillis (R-NC) would change Section 3 on escrow requirements, section 4 for Qualified Mortgage relief and section 6 for TILA/RESPA relief for credit unions and their members.
Treasury’s Report is not the sledgehammer to Dodd-Frank many feared it might be. The report sets major findings and recommendations on FSOC and OLA aside until October. The Report is not the oversimplification that was the tax reform one-pager. Nor is it the stuff of fantasy that was president’s budget. Low approval ratings coupled with delay on major priorities like tax reform and ACA repeal could be the motivation for a softer, more rational approach than was expected on financial reform.
Watch for the Senate Banking Committee and Leader McConnell to take the Treasury Department’s proposals or versions of them to the Senate floor.
The most concerning changes to watch are:
- 10 percent leverage off-ramp as proposed in the CHOICE Act
- Volcker rule changes (both in the banks exempted and in suggested changes to the definition)
- delayis to the Net Stable Funding Ratio and Fundamental Review of the Trading Book
- Supplementary Leverage ratio calculation changes
- CFPB defanging (similar to CHOICE changes)
- removing FDIC from living wills
- Increasing the 165 enhanced prudential standard threshold
The administration believes many of the proposed changes can come through the executive branch via regulatory changes. All of this leaves us with one final question: Would you prefer this report from Mnuchin or a different one from Bannon? Although this Report may not get many if any support from Democrats if only on account of the CFPB provisons. But the systemic destruction in these proposals is not as yuge as might reasonably have been feared.