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Big changes for little banks in Dodd-Frank reboot

By Stuart M. Saft, partner, Holland & Knight

Legislative bodies have a tendency to over-react to a crisis and, instead of waiting to see the actual cause and effect of the crisis, rush to legislate.

Frequently, the haste with which a legislature acts creates unintended consequences, particularly since it gives individual legislators an opportunity to legislate ideas that received little traction prior to the crisis.

This occurred in 2010 when Congress, reacting to the financial crisis which precipitated the Great Recession, enacted The Dodd–Frank Wall Street Reform and Consumer Protection Act.

In more than 2,000 pages of legalese, which few if any members of Congress read, Dodd-Frank created a legislative hydra that has negatively impacted the economy, particularly relating to real estate.

Interestingly, Dodd-Frank totally ignored the role that Congress played in causing the Financial Crisis.

Notwithstanding Congress requiring that lenders only lend to borrowers who could repay the loans, Congress also requires in the Community Reinvestment Act that lenders lend to borrowers who probably could not repay their loans.

Additionally, there was incredible irony in Congress instructing Fannie Mae and Freddie Mac to buy the subprime debt that was the proximate cause of the crisis, and then taking over Fannie and Freddie because it had too much debt from borrowers who could not repay their loans.

However, this was no more surprising than the federal government negotiating for sound financial institutions to take over failing financial institutions and then, after the recession, going after the resulting company and complaining that the problem was caused by banks being too large.

Of course, Congress also failed to notice that one of the reasons that the financial institutions were so large was because of a policy decision made during the Carter Administration when the government decided that it would be easier for the regulators to supervise fewer larger banks and then spent the next decade getting money center banks to merge. One of the things the real estate industry has seen is that, since the Great Recession, banks are playing a very small role in construction and permanent financing with hedge funds, private equity funds and foreign capital taking an ever increasing role due to the restrictions on lending contained in Dodd-Frank.

One solution is to recognize that current regulations are too complex and expensive and attempt to ameliorate the situation.  One alternative to Dodd-Frank is The Financial CHOICE Act: Creating Hope and Opportunity for Investors, Consumers and Entrepreneurs, which offers financial institutions an alternative i.e.,  if banks maintain a leverage ratio of liquid assets to overall debt of 10 percent, banks would avoid many of the other Dodd-Frank requirements and regulations.

Logically, if banks have a sufficient leverage ratio, they can cover their own losses, but it would also require banks to downsize, which would satisfy those believing that banks are too big.

Some of the other changes that are being considered by Congress include:

Repeal the “orderly liquidation authority” mechanism to unwind banks in a crisis, making enhanced bankruptcy the available method of resolving a failing bank. This would limit authority for the Federal Reserve and the FDIC to bail out financial institutions absent direct threats to overall stability.

Eliminate designations of “systemically important financial institutions” that confer heightened regulatory supervision on the institutions considered most too risky. This would also avoid insurance or large industrial companies from being treated as if they were banks.

Weaken the power of the Financial Stability Oversight Council, the risk monitor that approves the risk designations in order give authority back to the existing bank regulators.

Provide regulatory relief for community banks and credit unions, by exempting them from most Dodd-Frank rules and reporting requirements.

Require regulators to publicly disclose the framework of its stress tests, which would allow banks to prepare for them in advance.

Repeal the Volcker Rule, which banned proprietary trading by banks that take deposits. Repeal the Department of Labor’s fiduciary rule, which mandates the relation between brokers and their customers.

Enact a cost-benefit analysis for all new financial regulations. Enact the REINS Act, which would provide Congress a final vote on all major regulations from federal agencies. Congress is elected while the agencies give themselves enormous power that Congress never intended them to have by issuing regulations.

Eliminate court’s deference to federal agency interpretation of rules.

Narrow the minimum size of banks subject to the Financial Stability Council from over $50 billion in assets to over $200 billion.

Repeal section 129 C of the Truth in Lending Act, which requires that creditors not make a mortgage loan without making a determination that the buyer has the ability to repay, a determination that banks cannot make.

Another issue impacting would-be homebuyers is that the time it takes to finalize a loan from a bank has increased from about 30 days to 60-90 days, which causes homebuyers to be shut out by buyers who have cash in hand and thus can close a sale in days instead of months.

Finally, Dodd-Frank has limited the banks that can compete in the mortgage market who can meet all of
Dodd-Frank’s requirements because of the cost and complexity of its compliance requirements.

This has shut out credit unions and community banks across the country from being able to compete in the mortgage market, because they simply do not have the ability to satisfy the requirements of Dodd-Frank.

The result is that Dodd-Frank is causing the banks that can satisfy its requirements to grow larger, which is the opposite impact than it was supposed to have.

 

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