The Deregulation Promise Beginning to Bear Fruit


regulation-5-14-18.pngEd Mills, a Washington policy analyst at Raymond James, answers some of the most frequent questions swirling around the deregulation discussion working its way through Congress, the changing face of the Fed and other hot-button issues within the banking industry.

Q: You see the policy stars aligning for financials – what do you mean?
The bank deregulatory process anticipated following the 2016 election is underway. The key personnel atop the federal banking regulators are being replaced, the Board of Governors at the Federal Reserve is undergoing a near total transformation, and Congress is set to make the most significant changes to the Dodd-Frank Wall Street Reform Act since its passage. This deregulatory push, combined with the recently enacted tax changes, will likely result in increased profitability, capital return, and M&A activity for many financial services companies.

Perhaps no regulator has been more impactful on the implementation of the post-crisis regulatory infrastructure than the Federal Reserve. As six of seven seats on the board of governors change hands, this represents a sea change for bank regulation.

We are also anticipating action on a bipartisan Senate legislation to increase the threshold that determines if an institution is systemically important – or a SIFI institution – on bank holding companies from $50 billion to $250 billion, among other reforms.

Q: Can you expand on why Congress is changing these rules?
Under existing law, banks are subject to escalating levels of regulation based upon their asset size. Key thresholds include banks at $1 billion, $10 billion, $50 billion and $250 billion in assets. These asset sizes may seem like really large numbers, but are only a fraction of the $1 trillion-plus held by top banks. There have been concerns in recent years that these thresholds are too low and have held back community and regional banks from lending to small businesses, and have slowed economic growth.

Responding to these concerns, a bipartisan group in the Senate is advocating a bill that would raise the threshold for when a bank is considered systemically important and subjected to increased regulations. The hope among the bill’s advocates is that community and regional banks would see a reduction in regulatory cost, greater flexibility on business activity, increased lending, and a boost to economic growth.

The bill recently cleared the Senate on a 67-31 vote, and is now waiting for the House to pass the bill and the two chambers to then strike a deal that sends it to the president’s desk.

Q: What changes do you expect on the regulatory side with leadership transitions?
In the coming year, we expect continued changes to the stress testing process for the largest banks (Comprehensive Capital Analysis and Review, known as CCAR), greater ability for banks to increase dividends, and changes to capital, leverage and liquidity rules.

We expect the Fed will shift away from regulation to normalization of the fed funds rate. This could represent a multi-pronged win for the banking industry: normalized interest rates, expanded regulatory relief, increased business activity and lower regulatory expenses.

Another key regulator we’re watching is the CFPB (Consumer Financial Protection Bureau), which under Director Richard Cordray pursued an aggressive regulatory agenda for banks. With White House Office of Management and Budget Director Mick Mulvaney assuming interim leadership, the bureau is re-evaluating its enforcement mechanisms. Additionally, Dodd-Frank requires review of all major rules within five years of their effective dates, providing an opportunity for the Trump-appointed director to make major revisions.

Q: We often hear concerns that the rollback of financial regulations put in place to prevent a repeat of one financial crisis will lead to the next. Are we sowing the seeds of the next collapse?
There is little doubt the lack of proper regulation and enforcement played a strong role in the financial crisis. The regulatory infrastructure put in place post-crisis has undoubtedly made the banking industry sounder. Fed Chairman Jerome Powell recently testified before Congress that the deregulatory bill being considered will not impact that soundness.

Q: In your view, what kind of political developments will have effects on markets?
We are keeping our eyes on the results of the increase in trade-related actions and the November midterms. The recent announcement on tariffs raises concerns of a trade war and presents a potentially significant headwind for the economy. The market may grow nervous over a potential changeover in the House and or Senate majorities, but it could also sow optimism on the ability to see a breakthrough on other legislative priorities.

What is the Worst Aspect of Dodd-Frank?


The Dodd-Frank Act is the most substantial piece of financial legislation since the Great Depression, and also one of the least popular among bankers. But not everyone agrees what part of Dodd-Frank should be thrown out the window or changed. Is it the Volcker Rule? The Durbin amendment? How about the Consumer Financial Protection Bureau? Bank Director asked a group of attorneys to answer that question.

If you could change one thing in the Dodd-Frank Act, what would it be?

Smith_Phillip.pngI would not have established the Consumer Financial Protection Bureau (CFPB). It was not community financial institutions that initiated unfair, deceptive or abusive consumer practices, yet the trickle-down effect on smaller banks from enforcement endeavors against larger organizations will have a negative impact. Instead of punishing banks that did not cause the crisis with a brand new investigative arm of the government, what about focusing on the true troublemakers?

— Philip K. Smith, Gerrish McCreary Smith, PC

Lynyak-Joe.pngTitle XIV of the Dodd-Frank Act has required the CFPB to substantially rewrite the substantive and procedural rules governing the U.S. residential mortgage system, including application, underwriting and servicing of home mortgage loans. As part of that statutory mandate, severe limitations were placed on the origination of mortgages, including the creation of so-called qualified mortgages and rules on loan originator compensation. To enforce those limitations, penalties were expanded for originators, servicers and assignees of mortgages—without a statute of limitations. The optimum change would be to modify these mortgage rules in a manner that would facilitate the availability of credit by lenders by providing greater flexibility in the types of loans permitted, as well as limiting the liability for originators and assignees for violations. Failure to do so may inhibit the availability of credit to the home mortgage segment.

— Joe Lynyak, Pillsbury Winthrop Shaw Pittman LLP

fisher_keith.pngThe Dodd-Frank Act pretends to eliminate so-called too big to fail while actually enshrining it (using different words) in federal statutory law. Worse, the Act expands the scope of potential bailouts to include nonbank financial companies. Title I of Dodd-Frank, which creates the Financial Stability Oversight Council, greatly multiplies the degree of moral hazard and creates structural incentives for institutions not currently large enough to be considered Systemically Important Financial Institutions (SIFIs) to expand so as to aspire to join that exclusive club. From a public policy viewpoint, this is simply awful. Adding yet another unwieldy federal bureaucracy—the Financial Stability Oversight Council—to the mix is also fundamentally misguided. Outright repeal of Title I would be a vast improvement. Secondly, while the creation of a federal agency devoted to consumer financial protection may have been inevitable, having a large bureaucracy with a broad and diffuse legislative mandate and virtually unlimited funding seems misguided. At a minimum, the CFPB should be made subject to congressional oversight and the appropriations process.

— Keith Fisher, Ballard Spahr LLP

Mark-Nuccio.jpgThat’s an easy one—the Volcker Rule! Hugely reactionary and draconian, the post-Depression idea that banks should be kept almost entirely out of proprietary trading and private fund investment is epic silliness. Since Gramm-Leach Bliley, plenty of organizations handled their freedoms in these areas well. Instead, why not ban mortgage lending? There has to be a better way to address the perceived risks of the banned Volcker Rule activities. The risk to the economy created by the law (as well as the risk of further boggling the implementation of it) outweighs any possible benefit. Adopted more than three years ago and still waiting for final regulations (or better yet re-proposed regulations)—there’s a reason for that kind of delay—it’s a bad law!

— Mark Nuccio, Ropes & Gray LLP

Gregory-Lyons.jpgI would add a provision that expressly permits the agencies to tailor the law, either by regulation or on an individual institution basis, to ensure the rules to which an institution will be subject are appropriate for that institution. Dodd-Frank is a very broad, sweeping law, and that necessarily will result in it having unintended consequences for some institutions. For example, should insurance companies and other nonbank-centric financial services firms that either are designated as non-bank SIFIs or that retain a reasonably small bank presence be subject to the same capital rules as bank-centric institutions?

— Gregory Lyons, Debevoise and Plimpton LLP

Why We Need the CFPB


capitol.jpgFew pieces of legislation in recent years have riled up the financial services industry as thoroughly as the Dodd-Frank Act. And the white hot center of that controversial law is probably the new Consumer Financial Protection Bureau (CFPB), which the Act created to police the marketplace for personal financial services. If you’ve been reading the news lately, you know that the CFPB has a new director—former Ohio Attorney General Richard Cordray—who received a sharply-criticized recess appointment recently from President Obama. Senate Republicans had refused to hold confirmation hearings on Cordray until certain changes were made to the agency’s organizational structure, and Obama finally lost his patience and made Cordray’s appointment official while Congress was in recess.

If you have been paying attention, you also know there’s a difference of opinion between Senate Republicans like Majority Leader Mitch McConnell (R-Kentucky) and the White House over whether Congress was technically still in session, so the legality of Cordray’s appointment might be challenged in court. It’s also entirely possible—perhaps even likely—that the CFPB will be legislated out of existence should the Republican Party recapture the White House and both houses of Congress this fall. No doubt many bankers, their trade associations and the U.S. Chamber of Commerce would like to see that happen.

On the other hand, if the president wins reelection, I am sure he would veto any such bill that might emerge from a Republican controlled Congress, should the Republicans hold the House and retake the Senate this fall, which is possible but by no means assured. And if you give Obama a 50/50 chance of being reelected—which is my guess at this point having watched the Republican presidential race closely—then you can reasonably assume the CFPB has a 50/50 chance of surviving at least until January 2016.

And I think that’s a good thing.

cfpb-richard-cordray.jpgThis probably puts me at odds with most of Bank Director magazine’s readers. There’s no question that Dodd-Frank, combined with a variety of recent initiatives that have come directly from agencies like the Federal Reserve, will drive up compliance costs for banks and thrifts. And the CFPB‘s information demands alone will be a component of those higher costs. However, I have a hunch that what scares some people the most is the specter of a wild-eyed liberal bureaucrat imposing his or her consumer activist agenda on the marketplace. I don’t think Cordray quite fits that description, based on what I’ve read about him, but obviously we won’t know for sure until he’s been in the job for a while, so the naysayers’ apprehension is understandable. At the very least he seems determined to get on with the job, so we should know soon enough what kind of director he will be.

Here’s my side of the argument. Among the primary causes of the global financial crisis of 2008, which was precipitated by the collapse of the residential real estate market in the United States, were some of the truly deplorable practices that occurred during—and contributed to—the creation of a housing bubble. Chief among them were the notorious option-payment adjustable rate mortgages and similar permutations that allowed borrowers to pay less than the amortization rate that would have paid down their mortgages, which essentially allowed them to buy more house and take out a bigger mortgage than they could afford to repay. Some of these buyers were speculators who didn’t care about amortization because they planned on flipping the house in two years. But many of them were just people who wanted a nicer, more expensive house than they could afford and figured optimistically that things would work out. And the expansion of the subprime mortgage market brought millions of new home buyers into the market just when housing prices were becoming over inflated.

I’m not suggesting that the CFPB, had it been in existence during the home mortgage boom, could have single-handedly prevented the housing bubble. The causes of the bubble and the financial panic that eventually ensued were many and varied, including the interest rate policies of the Federal Reserve, the laxness on the bank regulatory agencies when it came to supervising the commercial banks and thrifts, the laxness of the Securities and Exchange Commission when it came to supervising the Wall Street investment banks and the fact that no one regulated the securitization market. But an agency like the CFPB, had it been doing its job, would have cracked down on dangerous practices like the so-called liar loans, or loans that didn’t require borrowers to verify their income. It would have put an end to phony real estate appraisals that overstated a home’s worth, making it easier for borrowers to qualify for a mortgage. And it would have been appropriately suspicious of option-ARMs if a super-low teaser rate and negative amortization were the only way that a borrower could afford to buy a home.

The CFPB is not a prudential bank regulator and will not focus on bank safety and soundness like the Federal Reserve, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. But in cracking down on some of these dangerous marketplace practices, the CFPB might have reigned in institutions like Wachovia, Washington Mutual, IndyMac and Countrywide that ultimately failed, or were forced to sell out, because it would have discouraged many of the shenanigans that helped feed the housing bubble.

Of course, many of the unsound practices that helped inflate the bubble were widespread outside the banking industry, and one of the CFPB’s principal—and I would say most important—duties will be to regulate the mortgage brokers and nonbank mortgage originators who accounted for a significant percentage of origination volume during the housing boom. Banks and thrifts should benefit greatly from this effort if it leads to the creation of a level playing field where nonbank lenders can no longer exploit the advantages of asymmetrical regulation.

A truism of our financial system is that money and institutional power will always be attracted to those sectors that have the least amount of regulation. For all intents and purposes, both the gigantic secondary market and the large network of mortgage brokers and nonbank mortgage lenders went unregulated during the boom years, and this is where the greatest abuses occurred. (Dodd-Frank also addressed the secondary market, although the jury is out whether its prescribed changes will work. Indeed, at this point it’s unclear whether the secondary market for home mortgages will ever recover.)

In hindsight, having two mortgage origination markets—one highly regulated, the other unregulated—was asking for trouble. And that’s exactly what we got.

Which is why we need the CFPB.

Will National Banks Lose the Protection of Federal Preemption?


justice.jpgIf you are the director of a nationally chartered bank or thrift, there’s a date coming up real fast that you must pay attention to. 

One of the many changes mandated by the Dodd-Frank Act is a significant restriction in the protection that banks and thrifts with national charters have enjoyed from many state consumer protection laws. That protection—under a legal principle known as federal preemption—is set to change significantly on July 21. While much angst has been expressed over the disruptive impact that the new Consumer Financial Protection Agency could have on the banking industry, that agency is still getting organized and its impact at this point is—at best—speculative. The end of federal preemption, on the other hand, could have immediate ramifications for national banks and thrift.

The idea of federal preemption in banking is a creature of the National Bank Acts (there were actually two, one in 1863 and another in 1864 which superseded the original law), which among other things created a federal charter for commercial banks and placed them under the control of the Office of the Comptroller of the Currency (OCC). Preemption received a huge boost in 1996 when the U.S. Supreme Court issued a landmark ruling that invalidated a state law that prohibited national banks from selling insurance in small Florida towns. 

And in 2004, under former Comptroller John D. “Jerry” Hawk, the OCC issued rules that preempted national banks and their operating subsidiaries from state laws that “obstruct, impair or condition” their ability to make loans and take in deposits, and also granted sole authority to examine and supervise national banks to—itself!

An apt description of this royal doctrine might have been: “The divine right of the OCC,” and it comes as no surprise that legitimate state interests have railed against the agency’s protective stance ever since. Consider this one example: During the home mortgage boom some years back, national banks doing business in Georgia were exempted from that state’s robust anti-predatory lending law while state chartered banks were forced to comply. Needless to say, state attorneys general and legislatures have been among the most vocal opponents of the OCC’s stand on preemption.

Although Dodd-Frank does not invalidate federal preemption altogether, it does state that the OCC can no longer issue sweeping rulings like it did in 2004, but instead will have to make preemption decisions on a case-by-case basis. It’s also possible that the scope of protection under federal preemption will end up being more narrowly constructed under Dodd-Frank, although it might take years of litigation before national banks and thrifts know exactly how much protection they have against state laws.

Who should be most concerned about the Dodd-Frank restrictions on federal preemption, set to take effect on July 21? Logically, it would be large national banks and thrifts with multi-state operations that include branch banking, home mortgages and/or servicing, home equity lending, auto finance, student lending and credit cards–in short, practically any consumer lending or servicing business.

Being forced to comply with multiple—and differing—state laws will drive up operating and compliance costs for large multi-state banks. Worse yet, it will expose them to the wrath of state attorneys general who couldn’t touch them before. As Arthur J. Rotatori, a Cleveland, Ohio-based member at the McGlinchey Stafford law firm puts it, “The purpose of this provision in Dodd-Frank is to empower state attorneys general to go after national banks.”

And no doubt they will.