By Representative Jon Huntsman
Is Dodd-Frank an appropriate regulatory response to the 2007 financial crisis? Tragically, no. That legislation ignores the government's pervasive role in causing the crisis, assures future transfers from taxpayers to bankers by institutionalizing a government backstop for "too big to fail" firms, and imposes massive new regulations and unreasonable compliance costs on smaller banks. As a result, lending to small businesses from small banks suffers.
The government helped bring on the recession by distorting the housing market through Fannie Mae and Freddie Mac, touching off financial bubbles driven by excessive credit creation by the Federal Reserve, granting a privileged position to toothless rating agencies, and allowing the capture of regulatory agencies by the biggest Wall Street players. The largest banks were pushing hard to take more risk at taxpayers' expense.
Today we can already see the outlines of the next financial crisis and bailouts. Mitt Romney admitted as much at last week's debate in New Hampshire. While he gave lip service to opposing bailouts, when asked how we would avoid bailouts he offered no solutions other than implying he would participate in a bailout of Greece. The Obama and Romney plan appears to be to cross our fingers and hope no "too big to fail" banks fail on their watch.
More than three years after the crisis and the accompanying bailouts, the six largest American financial institutions are significantly bigger than they were before the crisis, having been encouraged to snap up Bear Stearns and other competitors at bargain prices. These banks now have assets worth over 66% of gross domestic product--at least $9.4 trillion, up from 20% of GDP in the 1990s. There is no evidence that institutions of this size add sufficient value to offset the systemic risk they pose.
The major banks' too-big-to-fail status gives them a comparative advantage in borrowing over their competitors thanks to the federal bailout backstop. This funding subsidy amounts to roughly 50 basis points, or one-half of a percentage point in today's market.
The big banks' advocates claim that eliminating the too-big-to-fail subsidy would disadvantage American banks against global competition. But U.S. banks' major competitors in the United Kingdom are facing more sweeping regulatory curbs than any yet proposed here, including the possibility that the investment banking businesses of the large banks would indeed be allowed to fail. The big competitors in Switzerland, another large financial center, are being forced to hold significantly more capital to offset their risks to the government.
The U.K. is absolutely right to attempt to take away this implicit bailout subsidy, and it should be supported by the U.S. We need a level playing field, in which all banks on both sides of the Atlantic achieve solid footing without relying on the implicit guarantee of a government bailout. Experts agree that small and medium-size businesses would benefit if their lenders faced lower regulatory burdens and fair competition with the too-big-to-fail firms.
There is more than one fix. The best would be to eliminate Dodd-Frank's backstop. Congress should explore reforms now being considered by the U.K. to make the unwinding of its biggest banks less risky for the broader economy. It could impose a fee on banks whose size exceeds a certain percentage of the GDP to cover the cost they would impose on taxpayers in a bailout, thus eliminating the implicit subsidy of their too-big-to-fail status. Congress could also implement tax reform that eliminates the deduction for interest payments that gives a preference to debt over equity, thus ending subsidies for excess leverage.
Eliminating subsidies would encourage the affected institutions to downsize by selling off certain operations or face having to pay the real costs of bailouts. We need banks that are small and simple enough to fail, not financial public utilities.
Once too-big-to-fail is fixed, we could then more easily repeal the law's unguided regulatory missiles, such as the Consumer Financial Protection Bureau. American banks provide advice and access to capital to the entrepreneurs and small business owners who have always been our economic center of gravity. We need a banking sector that is able to serve that critical role again. Otherwise the sector's endgame will be continental Europe--an unsustainable socialist state and the death of entrepreneurship.
Hedge funds and private equity funds go out of business all the time when they make big mistakes, to the notice of few, because they are not too big to fail. There is no reason why banks cannot live with the same reality.