Dodd-Frank hasn't hurt banking or the economy, evidence shows

When he co-founded Houston-based Integrity Bank in 2007, Charles "Mack" Neff thought he knew the business: Take deposits, make loans, follow the rules and watch the money come in.

Well, the rule-following part got a lot more difficult after the financial collapse a year later and sweeping reforms that followed in a new law aimed at banning the riskiest practices at the root of the crisis and preventing future meltdowns of the financial system. Integrity more than quadrupled the number of people it had working to comply with regulations, hired consultants to interpret the law, and put the whole staff through "countless" hours of training.

"We're spending an enormous amount of time dotting our eyes and crossing our T's so that our compliance people don't end up with civil money penalties," said Neff, who has also made 15 trips to Washington in the past several years to push for the rules to be relaxed.

Neff's complaint is common among financial institutions, large and small, which are eagerly anticipating the promised dismantling of the law — known as Dodd-Frank — by President Donald Trump and the congressional Republicans. Despite complaints from banks, however, there's substantial evidence that Dodd-Frank has allowed banks to remain profitable while curtailing reckless behavior that sparked the financial crisis and the worst recession in 70 years.

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Take the latest analysis of bank earnings from the Federal Deposit Insurance Corp.: Net income reached an all-time high in the third quarter of 2016, and the proportion of unprofitable banks sank to its lowest level since 1997. As a percentage of revenue, expenses — excluding interest costs — are down to their lowest level since 2010.

Consumer advocates say that undoing reforms, which increased transparency in home buying and limited some of the Wall Street acrobatics that brought the global economy to its knees in 2008, would be a dangerous step. Woody Widrow is the executive director of RAISE Texas, a statewide coalition that coordinates financial education and savings programs.

After each financial crisis — which have occurred about every 10 years in recent history — banks and regulators then go through the same routine. "They get a slap on the hand at best, and they redesign things, and it always goes back to the way it was," Widrow says.

Fewer banks, bigger balance sheets

Texas banks might feel particularly aggrieved by financial reform legislation, because they started in a better position than most. Long before the last housing bust spurred waves of foreclosures across the country, Texas had learned from its own banking crisis.

More than 650 banks failed in Texas in the 1980s, following an oil price crash that dragged the housing market down with it. Realizing that lenders had overextended themselves with risky bets on wildcatters and real estate developers, lawmakers restricted some of the types of loans — such as those that offer low costs upfront, but require large payments at the end of the term — that can catch buyers by surprise or trap them into high interest rates.

In addition, the state's bankers adopted a culture of caution, which served them well in the housing bubble of the mid-2000s. During the crash, according to the Texas Department of Banking, Texas-chartered banks enjoyed decent returns on assets while nationally returns were negative. From 2008 through the beginning of 2010, only seven banks failed in the state, less than 1 percent of the total nationally.

But the new federal rules still applied to Texas, like every other state. The number of banks in Texas declined from 699 in 2007 to 533 in 2016, according to the Texas Department of Banking, mostly due to mergers. Steve Scurlock, an executive vice president with the Independent Bankers Association of Texas, which represents community banks, said the increased cost, time, and aggravation of complying with regulations — including older rules designed to guard against terrorism and money laundering — has driven smaller banks to sell out.

"We believe that the primary reason is that small banks are tired of trying to squeeze by with the heavy hand of government on their backs," says Scurlock, whose association has proposed a long list of trims for Dodd-Frank.

That wave of consolidation, however, has gone on for a long time. The number of banks nationwide shrunk by half between 1984 and 2003, as deregulation allowed increasingly global financial institutions to buy or crowd out smaller ones across the country. That trend did not accelerate after Dodd-Frank rules went into effect, and banks under a billion dollars in assets are exempt from a number of provisions of the law.  

In addition, while the profitability of small banks is running slightly below pre-crisis levels, the FDIC has attributed that primarily to a weak economy. Finally, demographics are playing a role in the decline of community banks. Young people going into finance are more attracted to the high-risk, high-return worlds of venture capital, hedge funds and private equity rather than plain-vanilla local banks.

"Texas has aging shareholders, aging management teams, and a lack of interest among the younger generations in running the banks," says Sanford Brown, a longtime financial services lawyer at Alston & Bird in Dallas. "It's not as much fun as it used to be, and you can't make as much money as you used to."

Frank Deviney, the president of Brush Country Bank in Freer in South Texas, agrees that conditions are tougher. He says Dodd-Frank has pushed him out of the mortgage business, but he can hang on — just not as easily as he could a decade ago.

"We're strong in capital, and still profitable, just not hitting a home run like we were before," Deviney says. "It's just a little nicer to make a lot more money."

Tighter credit — for a reason?

The reason regulators care about well-functioning banks is they support well-functioning economies, funneling the capital people need to start businesses and buy homes. Trump and congressional Republicans, say Dodd-Frank gets in the way of both. "It's almost impossible to start a small business," Trump said Monday.

In Texas, however, new business formations have continued to increase, hitting a record high in the first half of 2016. Dodd-Frank did tighten credit standards as an antidote to the subprime mortgage lending done with little regard to the borrowers' ability to pay, which precipitated the crisis. Still, home sales in the state have exceeded their pre-crisis peak.

"Dodd Frank, for all of the arguments for and against it, obviously the market learned how to deal with it," said Jim Gaines, chief economist at the Texas A&M Real Estate Center. "And if it was a problem, they learned how to overcome it."

Besides imposing new rules, Dodd-Frank also created a new regulator, the Consumer Financial Protection Bureau, to help prevent unscrupulous lending and practices by financial firms. Since 2012, CFPB has recovered $12 billion for consumers through its aggressive pursuit of mortgage servicers, debt collectors, auto finance companies, payday lenders and other financial businesses.

Having a federal agency devoted to consumer interests matters to people like David Ball, a Dallas marketing designer who lost his longtime contract with JC Penney in 2014. He sought a loan modification on the home he'd paid off for 21 years, and said a representative from CitiMortgage told him to ignore foreclosure notices while the modification was being processed, so he took no action. The bank then foreclosed, and Ball and his wife were evicted.

In January, the Consumer Financial Protection Bureau announced a $28.8 million penalty against CitiMortgage for similar tactics, and a few days later, the company's parent, Citigroup, said it would exit the mortgage servicing business.

Ball's complaint is still pending, but the judgment backed his belief that it was the company, not his own failings, that caused him to lose his home. "When you're just one guy, you don't have pull and lawyers and money," says Ball. "When it comes out how they do this to homeowners, it is a very big affirmation."

In a statement, Citigroup said it works with borrowers to modify loans, but it may foreclose if complete information is not submitted.

Is the economy safe?

Protecting consumers and businesses on an individual basis was not the main goal of Dodd-Frank, however. First and foremost, it was supposed to prevent another financial crisis. Did it succeed?

Some banks say yes, arguing the rules can now be relaxed.

"The systemic risk to the system today is virtually eliminated," said Jonathan Homeyer, who oversees commercial banking for Wells Fargo in South Texas, at an event in early December. "I'm a firm believer that markets make better determinations about risk-reward and the like, in ultimately rooting out bad behavior, than do government agencies."

Wells Fargo has just been through a months-long investigation by the Consumer Financial Protection Bureau into widespread fraud that led the bank's CEO to resign. A few days after Homeyer spoke, Wells Fargo failed a test designed to make sure the bank could go under without hurting the overall financial system and economy, and was forced to accept restrictions on future growth.

Still, some banking experts say, Dodd-Frank, doesn't go far enough to protect the financial system from "too big to fail" banks. For example, Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, has proposed requiring the largest banks to carry so much reserve capital that it makes economic sense for them to break into smaller pieces.

That doesn't seem likely under Republican rule in Washington, and Wall Street is betting on it. Stocks in the country's three biggest banks — JPMorgan, Bank of America and Wells Fargo — have risen by 16 to 35 percent since the election on Nov. 8.