On June 8, House Republicans voted to repeal major portions of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) and simultaneously passed H.R. 10 the Financial CHOICE Act by a 233-186 vote. Despite the outcome of this vote, a simple Republican majority in the House does not guarantee legislative passage; that requires subsequent wholesale Senate approval. In earlier articles, we talked about the challenges of dismantling Dodd-Frank, and the most likely replacement options, but this is where it gets interesting.
The traditional 60 vote filibuster-proof majority required in the Senate would definitely pre-empt a wholesale replacement passage of the House bill, given the Republicans hold only 52 seats in the upper chamber. However, reconciliation affords the Senate the option to devise and pass their own bank reform bill with only 50 votes, which is seemingly achievable, but still complicated. The CHOICE Act is controversial among some Republicans and even the banking industry, mainly because of its high capital component.
Realistically, dismantling Dodd-Frank in conjunction with a preferable replacement option comes down to a tradeoff of higher capital requirements for less regulation. As presented in my last post on the replacement options for Dodd-Frank, the Financial CHOICE Act was proposed by Jeb Hensarling (R-TX), chair of the House Financial Services Committee. The proposal would allow banks to opt out of certain provisions of Dodd-Frank in exchange for a relatively high 10% simple leverage ratio—considered a “blunt” measurement of a bank’s capital against total assets.
The modern banking risk model relies on the more sophisticated international Basel Committee on Banking Supervision (Basel III) capital approach that assigns a fixed “risk weighting to assets” (RWAs) by quality on a scale ranging from zero to 100 percent. For example, a zero risk-weighting might be assigned to a high-quality asset like G20 sovereign debt, as compared to a much higher risk-weighting assigned to lower credit quality, less liquid asset. Republican critics contend the Basel III approach is overly complicated and does more harm than good, because they say regulators impose their own opaquely devised system of arbitrary risk weightings on assets. Those critics also claim that large banks can “game” the complex system, which creates concentrations of invisible risks and exposures similar to those we saw in the financial crisis.
The Big Picture on FinReg
The drama surrounding health care reform has grabbed headlines, but rolling back financial regulations represents a major part of the overall Republican economic growth agenda. Driven by the goal of facilitating capital formation and job creation in order to spur economic growth, bank reform is the first of a three-pronged Republican approach towards greater prosperity, which looks like this:
- Bank Reform
- Trade Deal Renegotiation
- Tax Reform
So, what did the House dismantle?
House Republicans successfully framed the CHOICE Act as a jobs creation bill that will end “too big to fail” bank bailouts, punish Wall Street greed and deception, and remove prohibitive regulatory capital charges from the smaller community and regional banks so they can start lending again.
Summarizing the CHOICE Act, the focus is on repealing key portions of Dodd-Frank including:
- Repeal the authority of the Financial Stability Oversight Council to designate financial firms as systemically important financial institutions or “SIFIs” and eliminate the current system of annual bank capital stress tests and resolution plans (a.k.a. “living will”) submissions to the Federal Reserve Board and the Federal Insurance Deposit Corporation.
- Repeal the Orderly Liquidation Authority, which was designed to manage the liquidation process of insolvent large banks.
- Repeal the Volcker Rule, which restricts U.S. banks from engaging in certain kinds of speculative investments and limits bank ownership or sponsorship of hedge funds and private equity funds.
- Defund, restructure, and eliminate the supervisory structure of the Consumer Financial Protection Bureau (CFPB), then rename it to the Consumer Law Enforcement Agency under the Executive Branch.
- Repeal the DOL Fiduciary Rule, which is technically not a part of Dodd-Frank.
House Republicans have long looked for ways to weaken the powers and financial independence of the Consumer Financial Protection Bureau. The CHOICE Act would entirely restructure the CFPB oversight powers and sweep the authority of its director to serve at the pleasure of the president.
The independent Congressional Budget Office states on its website that the CHOICE Act would reduce federal deficits by $24.1 billion over the next decade. The office also say there is considerable uncertainty in its estimates.
Fiduciary Rule Response Highlights Political Divide on Regulations
While not directly related to Dodd-Frank, the Department of Labor Fiduciary Rule epitomizes the sharp political divide and acrimony that exists in Washington, D.C. The rule, which requires financial advisors to act demonstrably in the best interest of their clients when providing retirement investment advice, went into effect when the Obama administration circumvented Congressional approval and gave the DOL enforcement responsibilities.
Ironically, the public controversy around the rule propelled the term “fiduciary” into the vernacular of the conversation, which led to many major financial firms adopting the higher standard proposed by the rule as a way to deliver more efficient and transparent financial advice to their clients. This also allowed them to accumulate more fee-based assets under management—an important metric of profitability.
Though the DOL Fiduciary Rule is due to be repealed as the result of June’s vote, the nation’s largest banks remain relatively muted on the wholesale adoption of the CHOICE Act. Many prefer a more compromised approach of eliminating certain elements of Dodd-Frank and the Fiduciary Rule, while keeping others. This is not surprising given the industry has already invested large resources, changed businesses, and altered infrastructure to comply with guidelines, especially those in Dodd-Frank, a deeply rooted seven-year legislative behemoth.
What Next for Dodd-Frank?
Without providing specifics, President Trump's proposed fiscal 2018 budget estimated that repealing Dodd-Frank would save the federal government $35 billion over the next decade. As a replacement option, he has publicly suggested resurrecting the Glass-Steagall Act—a 1933 Depression-era law that mandated the separation of investment and commercial banking activity—against the advice of his senior economic advisors and treasury secretary. This would break up the largest U.S. banks, potentially eroding our global banking competitiveness and damaging the economy.
Resurrecting the Glass-Steagall Act will not happen in an already-over-crowded field of far more realistic replacement options. Far more probable is the softening, delaying, defunding, or even reinterpretation of various elements of Dodd-Frank. For example, a reinterpretation of the Volcker Rule, which lessens its burdens or somehow makes it less onerous, may be something that a majority in Congress may actually be able to pass.
The CHOICE Act now moves to the Senate, where its prospect of passage in current form remains extremely low. The narrow 52-48 Republican Senate majority means that, to avoid a filibuster and pass the CHOICE Act, the party will have to convince at least eight Democrats to vote to repeal Dodd-Frank, which the Democrats passed in the first place. Alternately, Senate Republicans could pass a more limited “compromise” regulatory relief bill along their own party line. For example, a modified Senate version might keep in place most of the existing complex capital rules requiring banks to hold to withstand market shocks and absorb losses. That being said, as we’ve seen on healthcare reform votes, reconciliation may not be any easier for the Senate.