If the Conservative Political Action Conference’s (CPAC) organizers wanted a speaker or panel on the causes of the financial crisis and what to do about too-big-to-fail financial insitutions, they could have chosen from among many conservative and libertarian experts who not only issued prescient warnings about government policies that egged on reckless behavior through subsidies, regulations, and flawed monetary policies, but also offered detailed free-market solutions to prevent future financial crises and taxpayer-funded bailouts
Such experts include John Allison, president and CEO of the Cato Institute, former chairman and CEO of BB&T Corp, and author of The Financial Crisis and Free Market Cure; Peter Wallison, counsel to the Reagan White House in the 1980s, co-director of the American Enterprise Institute’s program on financial policy studies, member of the Congressionally chartered Financial Crisis Inquiry Commission, and author of the new book Bad History, Worse Policy: How a False Narrative About the Financial Crisis Led to the Dodd-Frank Act; and Fred Smith, founder and chairman of the Competitive Enterprise Institute, where I work, and board member of CPAC’s parent organization, the American Conservative Union.
All of them sounded the alarms about the dangers of the government-sponsored housing enterprises Fannie Mae and Freddie Mac and mandates such as the Community Reinvestment Act, which encouraged banks to lower standards for borrowers in the name increasing home ownership. In congressional testimony in 2000, Smith warned that if anything goes wrong with the entities, taxpayers could be on the hook for “$200 billion tomorrow.” At the time, his warning was dismissed as exaggerating Fannie and Freddie’s risk, but it turns out he actually underestimated the amount for which taxpayers would later be on the hook.
Yet for CPAC’s single event on the financial crisis , held today, featured none of these experts. Instead, the sole speaker was Federal Reserve Bank of Dallas President Richard Fisher, who also has been a longtime Democratic operative with a decidedly big-government approach to financial regulation. Trying to appeal to the conservative audience, Fisher opened his speech with an anecdote about meeting President Ronald Reagan in 1984. He didn’t mention his having served in the Carter and Clinton administrations or his unsuccessful 1994 run as a Democrat against Sen. Kay Bailey Hutchison (R-Texas), in which he took standard liberal positions, including opposing school vouchers and supporting the Clinton “assault weapons” ban.
But putting all that aside, what are his current views on financial regulation? In his speech and in a Wall Street Journal op-ed earlier this week (co-authored with Dallas Fed Executive Vice President Harvey Rosenblum), FIsher rightly notes that the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act doesn’t end too-big-to-fail. Indeed, that’s what we at CEI have been saying since before the ink on the law was dry, and it is one of the bases of our lawsuit against Dodd-Frank. As our lawsuit notes, Dodd-Frank unfairly enriches the biggest banks both by designating them as “systemically important financial institutions” and massively increasing the regulatory burdens on their smaller competitors.
Fisher, however, does not exactly call for “repealing and replacing” Dodd-Frank. In the CPAC speech, he criticized the law as “long on process and complexity but short on results” and added that “regulators cannot enforce rules that are not easily understood.” Yet in neither the speech nor the Journal op-ed did he say which, if any, Dodd-Frank provisions he thinks should be repealed. In the op-ed, he called the law “a well-intentioned response” and concluded that “Congress should rewrite Dodd-Frank so that it actually ends the problem of banks that are too big to fail.” [Emphasis added] Without specifics, that could just as easily mean making making Dodd-Frank more stringent as replacing it with more rational rules.
The new rules Fisher does advocate likely wouldn’t end bailouts. Instead, they would limit the choices of consumers and entrepreneurs. He calls for large financial institutions to be “restructured” to “a size that is ‘too small to save.’” The main problem with this approach is it makes no distinction among the management of the banks. It would force the breakup of financial firms that grew big through prudence rather than recklessness—such as BB&T under John Allison’s leadership.
During his tenure as CEO from 1989 to 2008, Allison grew BB&T from a regional southern bank with $4.5 billion in assets into the 10th largest financial services holding company headquartered in the U.S., with $152 billion in assets. BB&T eschewed the type of reckless subprime loans that would eventually cause rivals such as Countrywide Financial and Wachovia to implode. Intead, it grew by making prudent loans and investments and providing excellent customer service. (Allison received the Lifetime Achievement Award from the American Banker magazine and was named by the Harvard Business Review as one of the 100 most effective CEOs in the world.)
Fisher’s plan also would likely force the breakup of successful mutual insurance cooperatives that hardly could be considered “Wall Street Banks” and that played no role in the mortgage crisis. These include firms such as State Farm Insurance, which also offers banking and brokerage services, and USAA, which offers specialized financial services to members of the U.S. military and their children. Well-managed financial firms such as these would also suffer due to Fisher’s proposal of government favoritism for “traditional commercial banks.”
Taxpayers would suffer as well. In the Journal op-ed, Fisher calls for “roll[ing] back the federal safety net … to apply only to traditional commercial banks, and not to the nonbank affiliates of bank holding companies or the parent companies themselves, where the safety net was never intended to be.”
Rolling back the “federal safety net” is always a good idea, but it should be rolled back for all financial activity. If a firm were forced to stop offering its customers insurance and brokerage services as a condition of its “traditional banking” unit receiving deposit in insurance, as Fisher suggests, consumers and would lose choices and the financial system likely would become less stable. There is nothing about lending that makes it inherently safer than other financial activity, such as investing or trading.
At its heart, the financial crisis was about bad underwriting in mortgage loans, many of which were securitized and sold to third parties. And though, to his credit, Fisher had been critical of Fannie Mae and Freddie Mac before they imploded, his new plan is virtually silent on reducing their destructive role in encouraging bad mortgages and other financial risks.
Phasing out Fannie and Freddie to allow the housing market operates without implied or explicit government support is the most important step in ending too-big-to-fail. Wallison and his AEI colleague Edward Pinto have shown conclusively that, since the 1990s, Fannie and Freddie misclassified millions of subprime mortgages—home loans made to borrowers credit scores below 660—as prime. The Securities and Exchange Commission filed a civil fraud suit late last year against former Fannie and Freddie executives, accusing them of misleading investors on the firms’ exposure to risky mortgages (the outcome of the suit is still being awaited in court).
For real financial stability, the Community Reinvestment Act must also be repealed. A new empirical study from the National Bureau of Economic Research concludes that the Act does indeed “lead to risky lending.”
How can we further end too-big-too-fail and level the financial playing field? It starts with reducing deposit insurance. Letting the unlimited deposit insurance for non-interest accounts from the Transaction Account Guarantee program, put in place during the crisis, expire last year was a good first step. Now, the federal deposit insurance limit should be reduced from $250,000 to the $100,000 that had been in place before the crisis. It’s hard to argue that folks with more than $100,000 in the bank need a “safety net” and can’t do their own due diligence
Healthy competition and innovation should also be encouraged among all types of financial institutions to get credit to the entrepreneurs who can jumpstart our economy. Congress should lift barriers to credit unions’ ability to engage in business lending. The threshold for registration with the Securities and Exchange Commission, based on the number of shareholders, hiked last year in the bipartisan JOBS Act should be further increased so that community banks can raise capital without going through the onerous accounting mandates of Sarbanes-Oxley—especially since they already go through stringent audits from bank examiners. And banking regulators should lift the moratorium preventing retailers such as Walmart, Home Depot, and units of Berkshire Hathaway from creating their own limited banking operations.
We can only hope that next year, CPAC offers some real free-market perspectives on ending too-big-to-fail and lifting barriers to a vibrant financial system for American consumers, investors, and entrepreneurs.
CEI Research Associate Evan Woodham contributed to this post.