Reforming Dodd-Frank (When the Law Works)

Let me begin this column with a personal disclosure: I refinanced my house in December.

So I have first-hand knowledge of just how frustrating compliance with modern mortgage lending can be, at least on the consumer side. Plenty of compliance officers also talk about the frustration of compliance burdens on the lender side, and how the Dodd-Frank Act is imposing painful costs on anyone and everyone who makes a living in the mortgage business.

And yet, here’s the thing: apparently the Dodd-Frank Act isn’t imposing much harm on the mortgage industry as a whole. So anyone waiting around for wholesale reform of Dodd-Frank—which is pretty much the entire Republican Party—should forget it.

That’s the implication of a study released by the Government Accountability Office at the end of December, which looked at the costs of Dodd-Frank compliance and its consequences for mortgage lending. Yes, many financial firms are spending more on compliance: hiring staff, training staff, buying software, changing processes. Community banks and credit unions are taking particularly hard hits since they have fewer resources to meet compliance burdens easily. But mortgage lending overall has held steady, the GAO found, except for a decrease in non-qualified mortgages that nobody wants to originate any more, because they can’t resell those lower-caliber loans on the secondary market.

Let’s pause here to remember: that last part is what Dodd-Frank was supposed to do. And that fact will carry subtle but significant weight as Washington chatters about how Dodd-Frank should be reformed.

Start with the history. The financial crisis of 2008 was caused by sloppy oversight (or no oversight) of mortgage lending; which led to balance sheets hugely swollen with financial assets worth nothing near what the numbers said; which led to a freeze in inter-bank lending because nobody knew what those mortgage-backed assets actually were worth; which led to the government’s $700 billion bailout and the Wall Street crash seven years ago. All of it traces back to rotten practices in mortgage lending.

That’s why Dodd-Frank compliance today drives bankers and refinancing customers like me so nuts—because it was always going to drive us nuts. The whole purpose of the Dodd-Frank Act was to bring discipline to an undisciplined part of the finance world. Yes, lots of other issues were crammed into the final legislation too, and another day we’ll talk about how bad many of those ideas were. But never confuse them with the fundamental mission of Dodd-Frank: to clean up the business of mortgage lending.

The GAO report studied 35 significant Dodd-Frank rules, overseen by the usual regulators: Securities and Exchange Commission, Consumer Financial Protection Bureau, Commodities and Futures Trading Commission, National Credit Union Admiration, and others. The report also warned that none of its conclusions should be considered comprehensive or final, because so many Dodd-Frank rules still haven’t been written. It tried to gauge “compliance burden” by a few different metrics, such as number of employees per $1 million in assets and non-interest expenses as a percentage of assets; and looked at Dodd-Frank’s effect on community banks and credit unions on one hand, large banks on the other.

The findings about how financial firms comply with Dodd-Frank aren’t shocking. Small banks and credit unions, with fewer staff and resources, struggle harder to meet Dodd-Frank’s compliance burdens. Large banks struggle with compliance too, but less than their smaller brethren. No surprise there.

The more interesting question is how Dodd-Frank compliance might be affecting mortgage lending and the financial system overall—and to a large extent, the answers are perfect respectable. The only lending that has seen an appreciable squeeze is non-qualified mortgages originated by small banks and credit unions, because those loans carry extra risk and liability for default. Or as the GAO unpoetically puts it, “Representatives from two community banks said that many banks have been unwilling to originate loans that cannot be sold on the secondary market.”

Well, think about what that really means: if banks are confronted with the possibility that they might need to carry questionable loans on their own books, rather than resell the loan and pass on that liability to someone else, the banks are less inclined to issue those loans in the first place. That is not a bad thing. Call me crazy, but I thought that’s how the system is supposed to work.

The study’s findings about large banks are more compelling, and edge closer to questions about reforming Dodd-Frank. For large banks, the GAO found, Dodd-Frank compliance has led to improvement on some indicators of bank safety and soundness, but “no evidence” of increased funding costs. The fear from Dodd-Frank critics had always been that compliance would drive up those funding costs, which might drive banks to extend less credit, and that would be particularly dangerous during a financial crisis. So far, those increased costs aren’t emerging.

Let’s Get Political

Conclusions like that are nothing Dodd-Frank critics (read: Republicans) want to hear, especially as we go into an election year. Remember how the push for reform is supposed to work. The banking lobby tells Republicans in Congress to fight the Dodd-Frank Act, so Republicans dutifully say it imposes too much regulatory burden, and therefore stifles economic activity. Well, yes and no. Clearly the Dodd-Frank Act has made banking a less lucrative business, and the tens of thousands of bankers laid off in 2015 would certainly say their economic activity has been stifled.

Still, the GAO report shows that Dodd-Frank hasn’t caused any systemic harm to the financial system overall. People still get mortgages and refinancings. The paperwork to complete them is more maddening, but deals still close and get resold in the secondary market. And if the mortgage market continues to be stable, then the Dodd-Frank Act has done what it’s supposed to do: bring stability and reduce the chances of another financial crisis.

Could Dodd-Frank be improved? Absolutely. But critics demanding wholesale repeal aren’t going to carry much weight with voters, because voters can’t see any specific problem to address, because there isn’t one. Voters—especially in the Republican camp, which is the only party interested in repealing Dodd-Frank—are more concerned with (alleged) problems they can see, like Islamic terrorism or illegal immigration. Calls to abolish, or even just amend, the Dodd-Frank Act simply aren’t going to stick.

Hence we do see reforms that are more focused and politically feasible, like the easing of rules for capital-raising that was included in the FAST Act passed in December. Or we could see Republicans in Congress try the tactic of expanding the threshold for exemptions that already exist—classifying more businesses as Emerging Growth Companies for longer periods, perhaps; or exempting small businesses from XBRL filing requirements. (This also assumes Washington can agree to pass anything at all in an election year.)

But for anyone in the mortgage business specifically, or anyone who wishes Dodd-Frank would just go away entirely—that’s not going to happen. And according to the evidence so far, nor should it. Republican candidates will harp about Dodd-Frank to placate conservative audiences, certainly, but that’s all they will do. It’s pro forma political theater for conservative audiences.

I will never say that Dodd-Frank is a “good” law; it has imperfections and bad ideas to spare. At the same time, however, it also has many parts that do work to achieve the broad policy goals that seven years ago we all said were important. Those are the parts that will make this law, in some form or another, endure for years to come.


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