THIS IS EXACTLY THE WRONG TIME TO ROLL BACK FINANCIAL REFORM / THE FINANCIAL TIMES OP EDITORIAL

This is exactly the wrong time to roll back financial reform

The US is at the end of a recovery cycle, with debt loads at record levels

Rana Foroohar



Financial crises always start the same way. Loose monetary policy leads to an increase in debt and a rise in risk-taking. Over-confident financiers, lax regulators and politicians desperate to please voters operate in this toxic environment until a bubble eventually bursts, taking the financial system down with it.

I am not saying we are heading for this fate in the very near future. But it is worth noting that this coming week the US Congress may very well pass a bill to rollback the post-financial crisis-era Dodd-Frank reforms. This is happening at a time when interest rates have been at historic lows for nearly 10 years, public and private debt is at record levels, consumer debt loads and subprime defaults are rising, and politicians are looking to throw a bit more kerosene on the economy to seduce voters in the run-up to November’s midterm elections.

The bill, authored by Mike Crapo, the Republican head of the Senate banking committee, is being couched as a way to reduce onerous regulatory burdens on regional and community banks so that they can do more of the plain vanilla lending — to farmers, or young couples looking to buy a home — that plays well at the ballot box.

Yet the numbers show that loan growth at community banks is already stronger than the industry average (up about 8 per cent a year for the past two years) led by growth in commercial real estate loans, residential mortgages and commercial and industrial loans.

“There’s zero evidence of a credit supply problem,” said Dennis Kelleher of Better Markets, a financial reform advocacy group. “Given that we’re late in the business cycle, we have wage stagnation, and debt loads that are now at pre-crash levels, the only way to deploy additional lending would be to lower underwriting standards.”

A report released last week by the New York Federal Reserve, found that there has been a complete recovery in US housing wealth or equity since the 2008 crisis. But at the same time, housing market dynamics have also changed substantially. Nearly all of the rewards have gone to the richest and most creditworthy borrowers, while the number of younger people moving from renting to owning has declined precipitously.

While tight credit is part of the problem, Beverly Hirtle, the executive vice-president of the New York Fed, notes that the underlying issue “seems to be the increase in other forms of debt — notably student loans — among younger borrowers with lower credit scores”. Encouraging these types of borrowers to take on housing debt, even if they were inclined to, obviously will not help growth or financial stability.

Meanwhile, the bipartisan group of Congress members who are pushing the bill forward is downplaying the fact that it offers two important carrots for larger banks with assets ranging from $250bn to more than $2tn. These institutions will now be able to reclassify municipal bonds as “high quality assets”, making it easier for them to game the liquidity coverage ratio. Custodian banks, such as State Street, BNY Mellon and Northern Trust, will also benefit from a softening of post-crisis capital standards. They will be allowed to deduct client cash from their leverage calculations — something that could benefit even large banks such as Citigroup or JPMorgan that have custodial business.

Rolling back these particular rules is not going to trigger a crisis. The US banking industry is better capitalised than it was in 2008. The next big market debacle is more likely to emanate from the corporate world than from banks.

Even so, this “reform” bill takes us in exactly the wrong direction, at precisely the wrong time. As experts such as Tom Hoenig, former vice-chair of the Federal Deposit Insurance Corporation, have pointed out, there is ample research to show that banks with higher capital levels lend more, not less. Even an equity-to-assets capital ratio of 15 per cent (about triple what institutions must hold today) significantly reduces the risk of bank failure, with only a small increase in lending costs.

Now would be a good time to raise capital standards on safe haven banks that sit at the centre of the capital markets, rather than lower them. It is always a good idea to have a cushion before the next crisis comes.

This bill will do just the opposite. It will also roll back the Volcker rule prohibitions on proprietary trading done by banks with less than $10bn in assets. It is true that those institutions rarely gambled before. But in an environment in which bank margins are likely to remain compressed for a variety of reasons (including weak demand and competition from lower-priced Silicon Valley rivals), will even smaller institutions resist the temptation to reach for higher yields in the future? I doubt it.

The latest Dodd-Frank rollback bill comes, of course, at a time when financial deregulation efforts are also gaining steam at the Treasury, the Securities and Exchange Commission, the US Federal Reserve, the Office of the Comptroller of the Currency, the Commodity Futures Trading Commission and so on.

Is this where we want to be at the end of a recovery cycle, with debt loads at record levels and the interest rate environment changing? No. Sadly, short memories and rollbacks of post-crisis reform are another common refrain in financial history.