During the presidency of George W. Bush, lax regulations of the financial sector and lack of monitoring of the housing bubble formed under the stewardship of Alan Greenspan, former Chairman of the Federal Reserve Board (FRB), finally culminated into credit freeze and a full blown financial crisis that led to the demise of prominent financial institutions such as Lehman Brothers. The financial meltdown of 2008 led to severe recession with double-digit unemployment rate, bursting of the housing bubble with downward spiral of home sales and prices, and crash of the financial markets. The bank bailout program (TARP), initially proposed by Bush and implemented by the incoming President Barack Obama, and tougher regulations of mortgage-based securities and sub-prime mortgage lending, initiated by the incoming Fed Chairman Ben Bernanke, led to unprecedented tighter controls of the too-big-to-fail banks. The new bank regulations now require all major banks to go through the so-called stress tests conducted annually by the FRB to ensure that the banks have enough capital to survive systemic failures within the financial system. In 2010, the Congress passed the laws giving FRB and other regulators expanded authority that covered origination of mortgages, credit- and debit-card payments, ban on proprietary trading done with the depositors' money, capital structure, consumer complaint bureau, and literally dozens of other changes. Banks are now required to get approval from the government before they could return capital to shareholders via dividends and share buyback programs.
More recently, the U.S. Justice Department, State Attorney Generals, and other bank regulators have also been aggressively going after major banks in courts and suing them for their role in precipitating the 2008 financial crisis and collecting billions of dollars in punitive settlements. The government officials, while taking a cue from the Occupy Wall Street protesters, have acted to punish banks via criminal charges and otherwise ruin their reputation, supposedly reflecting the will of the people. There has been no restraint on the part of government officials because they know that the people hate banks and that unpopular banks are afraid to fight the cases in the court fearing that they would lose. Theoretically, if they lose the criminal cases in the courts, they could lose their charters and be put out of business. In the absence of any force to restrain their actions, the regulators have slipped into this mindset that they can do pretty much anything they want to do to punish the banks.
From Bush to Obama and from Greenspan to Bernanke, the pendulum of our financial regulatory regime has dramatically moved from one extreme (lax regulation) to the other (over-regulation).
In the aftermath of the financial crisis of 2008, the Congress hastily enacted some of the extreme regulations out of panic to avoid the repeat of the depression of the 1930’s. Also, Bernanke deployed unprecedented approaches to provide financial stimulus to economy through the so-called Quantitative Easing (QE) programs and near-zero interest rates to revitalize the housing market and to induce investors to start taking risk again. To some extent, Bernanke was forced to aggressively pursue expansive monetary policy (in spite of fears of increasing inflationary expectations) because of the unbridgeable ideological differences between the Democrat-controlled Senate and the Republican-controlled House that prevented them to agree on any meaningful fiscal stimulus. The FRB's policies did help improve the housing and financial markets and bring down the unemployment rate from over 10% to 6.3% (most of the job gains, however, has been in the low-wage retail sector while high-paying manufacturing jobs have been lagging). The recovery from the great recession, however, has been painfully slow and the GDP growth has mostly stuck in a moderate 2 – 2.5% range, which is uncharacteristically lower than in the recoveries from the past recessions. It is now becoming clear to some lawmakers that over-regulation of banks is one of the primary reasons for slow recovery, aside from political gridlock in Washington, DC that prevented timely decisions on fiscal stimulus, tax reforms, and reduction of federal budget deficit and debt.
Below are some examples of how over-regulation of banks is negatively affecting economy:
· Regulations have become too complex, which has increased the cost of
compliance by billions of dollars that banks are forced to pass on to the
consumers in the form of higher fees for services and higher interest rates on credit
cards and loans. Also, complex regulations are
making banks commit honest mistakes in financial reporting that negatively affect their
stock prices. Recently, Bank of America found an unintentional error in how
they calculated capital ratios in their filing to FRB and that news alone crashed
its stock by over 7% hurting many middle-class families who owned the stock.
· Banks are now required to submit their annual capital plans to the
regulators as part of the stress tests. If a bank fails the test, the news headline
can crash its stock, as was the case with Citigroup this year. The FRB’s stress
tests involve some subjectivity and, therefore, it’s hard for any bank to know
with confidence if it will pass the test. In case of Citigroup, which was
supremely confident that they will pass the test, the FRB made different
assumptions regarding the bank’s risk factors in markets outside the U.S.
and that resulted in FRB giving Citigroup a failing mark. The FRB decision practically
killed Citigroup’s plan to increase dividend to shareholders this year and that
crashed its stock. In a free-market economy, the FRB making decisions on
whether a bank can increase dividend or buy back their company shares is
unprecedented and unsustainable. The government intrusion in making these kinds
of micro decisions based on subjective evaluation of risk factors is way too
heavy-handed and unnecessary. These intrusive regulations have made banks overly
conservative in their lending standards to ensure that their risk profile would be acceptable to the regulators. Lack of easy capital
availability hurts small businesses, potential home buyers, and home owners who
would like to take advantage of low interest rates and refinance their mortgage
loans. The jumbo mortgage loans are hard to come by, even in the face of increasing demand for such loans. The cautious stance by
banks, prompted by over-regulation, has reduced the velocity of money
exchanging hands throughout the economy, making it harder for the economy to
grow faster. If we didn't have many of these regulations, we would have already
seen GDP growing at 4% or higher rates.
The Congress should hold hearings and look at all regulations that have been enacted since the financial meltdown including the radically expanded role of the FRB. The goal should be to simplify regulations and make them less intrusive so the banks would become a little more aggressive in lending which will fuel growth and create jobs faster. Also, DOJ and other regulators should pull back from their aggressive posture in filing law suits against banks that are making them overly cautious in lending and extremely conservative in risk taking. In 2008, banks were part of the problem, but now they are part of the solution; without banks' increased risk taking and lending, we cannot achieve higher growth rates that are necessary to reduce unemployment and increase wages.
