The United States has a rich history of bank crises. In fact, we’re number two in the world, with 13 all-time, just behind France with 15, and just ahead of the United Kingdom, with 12. Our first major banking regulation law, the National Currency Act, was passed in 1863 as a response to a bank failure rate of fifty percent. Each successive crisis, the Panic of 1907, the Great Depression, the Savings and Loan Crisis of 1982, the Housing Bust of 2007 (to name a few) triggered a new wave of financial regulation. Dodd-Frank, passed in early 2010, is the latest of these waves.
There’s a saying in the military that generals spend a great deal of time fighting the last war. It strikes me, looking at the historical pattern, that this is also true of financial regulators. They pass laws and make changes based on what happened last time, but the next crisis is always based on a new systemic weakness that no one sees. Dodd-Frank builds on this history by adding major new regulations that create massive compliance costs while keeping the same problems that led to the crisis in the first place.
I came to Congress a little over four months ago. If I leave Washington having helped put through a law that will break the bailout, regulate, rinse, repeat cycle, I will consider the time away from home well spent. I serve on the Financial Services Committee, and we’re working on a bill that I think will go a long way towards stopping the bailouts, while at the same time cutting back on the Dodd-Frank red tape that’s been slowly strangling community banks.
The core of our bill, the Financial Choice Act, is relatively simple, as bank regulation goes. Under the bill, banks in essence have two options: they can live under Dodd-Frank, or they can keep a certain amount of high-quality capital on hand to cushion losses. That amount, or ratio, is around 10 percent of their total loans or investments, more than triple what the big banks had on hand pre-financial crisis. In fact, of the banks that did have a 10 percent ratio during the crisis, more than 98 percent survived. Right now most of the big banks are hovering a little above 6 percent, and requiring them to go to ten would cost them billions in foregone profits. If that means that the system as a whole is more durable and banks get out from under Dodd-Frank, then I think that’s a fair tradeoff.
Most community banks, on the other hand, are well above 10 percent. For instance, Blue Harbor Bank in my district has a ratio of 15 percent. That’s not out of the goodness of their heart–community banks know that if they fail, the federal government won’t bail them out, so they have to operate more conservatively. They don’t get to cover their bets with taxpayer funds, and as a result they’re more careful with the loans and investments they do make. At the same time, they’re hit with Dodd-Frank regulations. Even now, large banks keep lower ratios in part because of the widespread assumption that they will be bailed out in a crisis. What the 10 percent requirement of the Financial Choice act is about is levelling the playing field–treating all banks equally, large and small.
That brings me to another feature of the bill, which creates an orderly method to unwind failed financial institutions through the bankruptcy courts. Chapter 11 bankruptcy has historically been the way insolvent business are dealt with, providing a path for debtors to continue business operations and creditors to get their money back, if possible. It’s not well-designed for large financial institutions because it does not take into account the notion that the company in bankruptcy may impact the national economy, something that is true for very large banks but not for most companies.
The Financial Choice Act adds a new section to chapter 11 to allow financial regulators the opportunity to participate in the bankruptcy process, and to ensure that bankruptcy of a large bank does not cause a full-blown crisis. The benefits of having a clear process up front for unwinding big banks means that there’s a clear plan of action in case a crisis occurs, eliminating the need for bailouts.
Together, these two provisions both significantly reduce the chance of future crises, and reduce the chance of future bailouts. There is no question that our country will have its 14th financial crisis at some point in the future. We owe it to the country to do everything we can to make sure that we reduce its impact through sound regulation, so that when it does happen, big banks that take on too much risk are subject to the discipline of a well-established legal process, not a bailout.
Congressman Ted Budd serves the people of North Carolina’s 13th congressional district in the U.S. House of Representatives.