by: Sherrill Shaffer, PhD
The 2007-2009 financial crisis was massive, costing at least $16 trillion by several recent estimates. This cost was more than a full year’s U.S. GDP at the time, more than total U.S. banking assets, and more than twice the total inflation-adjusted cost of all U.S. wars ever!
Overall, the economy has yet to recover fully from the crisis. A recent study by the Pew Institute reports that nearly all states (including Wyoming) still have lower employment rates than in 2007! In fact, Wyoming’s employment recovery lags behind the national average as of the report date, standing 4% below our pre-crisis level.
Naturally, legislative, regulatory, and policy responses to the crisis were dramatic, centering around Dodd-Frank, Basel III at the international level, and the Fed’s Quantitative Easing (QE). Banks in Wyoming and elsewhere, as well as society at large, are now facing the costs of those responses, and – we hope – enjoying some benefits that they were intended to provide.
Congress has established a web site to track the cost of complying with Dodd-Frank; see http://www.financialservices.house.gov/burdentracker/. It reports (as of April 2015) that more than 24 million staff hours are required each year to comply, with nearly half the rules remaining to be written – 25% greater than the total man-hours required to build the Panama Canal! This is in addition to the cost of complying with all other pre-existing bank regulations still in effect.
The cost of regulatory compliance is a matter of public concern because it affects all of us. Ultimately, it is not just banks that bear this cost, since they have to earn enough to pay their depositors, their employees, their taxes, and all other expenses (including regulatory costs). So any new regulatory costs must be passed on to everyone else, in the form of higher fees on loans, lower interest paid on deposits, and so on. This is a hard reality (like gravity) that cannot be legislated away. Therefore, as a society, we need to be informed and thoughtful about weighing those costs against the benefits. But this is tricky, because the benefits of successful financial regulation largely accrue via counterfactuals, such as preventing another crisis that would have happened, which cannot be directly observed or measured.
Another complication is that, under any regulatory program (as in many unregulated outcomes), there are winners and losers. Following the crisis, simplistic bumper stickers singled out “Wall Street” versus “Main Street” as the relevant camps. But Main Street itself is not a single homogeneous group: There are consumers – but also merchants, who are also consumers. There are community bankers, who are part of Main Street and not Wall Street. Among consumers, there are wealthy, middle class, and low-income households, all with distinct needs and preferences. Compounding the conundrum is that fact that, unlike state or local responses, federal regulatory responses inherently impose a uniform, “one-size-fits-all” perspective regardless of regional variations in conduct, culture, needs, or ability to bear compliance costs. Letting the states, rather than Washington, take the lead on regulatory reform could avoid this problem, though at a cost of duplicating (up to 50 times!) the investigative effort to generate appropriate legislation, and without solving the question of what rules the federal banking regulatory agencies should write.
Several important questions follow from these considerations:
- Are the benefits of current bank regulation commensurate with the costs? How can we tell?
- Are there less costly ways to attain comparable benefits?
- Is there a good way to avoid the pitfalls of a “one-size-fits-all” regulatory program? (Talking about reducing the burden for community banks addresses only part of this problem, and even that has not been adequately implemented.)
- An ideal regulatory program, like an ideal market economy, would produce win-win outcomes for all parties, rather than pure winners and losers. How can financial regulation best approach that ideal?
- Do current laws and regulations embody a punitive component, incorporated (even subconsciously) by their authors amid the wave of finger-pointing that followed the crisis? Would we as a society be better served by making a clearer distinction between normative and punitive components?
- To what extent does the current regulatory environment encourage people (consumers, bankers, investors, and others) to stop thinking critically for themselves but instead to assume mindlessly that the regulations cover all aspects of sound decision-making regarding personal credit, banking practices, risk-taking, or other aspects of financial transactions? Is this an extra, hidden cost of comprehensive regulation?
- As a society, where do we want to be along the spectrum between personal freedom and collective paternalism, recognizing a tradeoff between regulatory constraints on personal financial risk versus latitude for personal choice? Is that, indeed, a question that cannot be equitably decided via traditional democratic processes, in view of the asymmetry arising from the fact that proponents of personal freedom would not want to impose rules on others, while proponents of paternalism specifically want to impose rules on everyone?