The Presidency, Congressional Republicans, and the Future of Financial Reform

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Peter Conti-Brown University of Pennsylvania

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Recommended Citation Conti-Brown, Peter, "The Presidency, Congressional Republicans, and the Future of Financial Reform" (2017). Wharton Public Policy Initiative Issue Briefs. 42. https://repository.upenn.edu/pennwhartonppi/42

This paper is posted at ScholarlyCommons. https://repository.upenn.edu/pennwhartonppi/42 For more information, please contact [email protected]. The Presidency, Congressional Republicans, and the Future of Financial Reform

Summary This brief examines the tension between the Republican ideological commitment to curbing executive power and the opportunity Republicans now have for Trump to dominate the direction of financial regulatory reform. The discussion will focus on three key policy outcomes that Republicans have sought during the last six years: reforming the Federal Reserve, overhauling the Consumer Financial Protection Bureau, and changing the way in which the nation’s largest financial institutions are designated and regulated.

Disciplines Business Law, Public Responsibility, and Ethics | Economic Policy | Finance | Public Policy | Securities Law

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This brief is available at ScholarlyCommons: https://repository.upenn.edu/pennwhartonppi/42 publicpolicy.wharton.upenn.edu The Presidency, Congressional ISSUE BRIEF VOLUME 5 Republicans, and the Future NUMBER 2 of Financial Reform FEBRUARY 2017

Peter Conti-Brown, JD

As the curtain falls on the Obama presidency, historians have already begun to put the past Administration into a broader context.

While only the Affordable Care Act will be identi- SUMMARY fied by the former President’s name—even Obama has embraced the Obamacare moniker—the Wall Street • When it comes to financial regulation, many have assumed Reform and Consumer Protection Act of 2010, or that the Trump Administration will now work in concert with a Dodd-Frank, will figure prominently in any assess- Republican-controlled Congress to repeal Dodd-Frank in full— a move anticipated in the CHOICE Act, a piece of legislation ment of Obama’s legacy. introduced by Republicans in September 2016. But there are As with its older sibling, how Dodd-Frank is reasons to believe that this will not be so straightforward. assessed will be a partial function of how much of it survives. Since before its enactment in July 2010, • Republicans fashioned the CHOICE Act in anticipation of a Hillary Clinton presidency, with the goal of limiting the execu- Republicans have been circling wagons to amend it, tive’s discretion in response to financial risk. In light of Donald gut it, or repeal it. Now that the party has assumed Trump’s unexpected rise to the Presidency, it is possible that control of both houses of Congress and the White some Republicans may start reevaluating the benefits of limiting House, some skeptics are ready to forecast the disman- executive authority. And recent comments by President Trump’s tling of Dodd-Frank. For support, they point to the pick for Treasury Secretary, Steven Mnuchin, suggest that the Financial CHOICE Act, a piece of legislation intro- Administration favors keeping some aspects of Dodd-Frank. 1 duced by Republicans in September 2016. • This issue brief examines the tension between the Republican Not so fast. While the CHOICE Act would ideological commitment to curbing executive power and the certainly amount to a wholesale repudiation and near opportunity Republicans now have for Trump to dominate the complete repeal of Dodd-Frank’s key provisions, a dif- direction of financial regulatory reform. The discussion will ficult political dynamic is underway that the election focus on three key policy outcomes that Republicans have of Donald Trump complicates, rather than facilitates. sought during the last six years: reforming the Federal Re- At play is both an ideological difference in how the serve, overhauling the Consumer Financial Protection Bureau, and changing the way in which the nation’s largest financial government should approach financial reform, but also institutions are designated and regulated. institutional differences that have more to do with presidential politics than partisan ideology. publicpolicy.wharton.upenn.edu

In this Issue Brief, I will discuss THE POLITICAL DYNAMICS The CHOICE Act reflects those those two sometimes conflicting moti- OF FINANCIAL REFORM twin pillars. The surprise election of vations behind Republican reform Donald Trump suggests to many, of the financial sector and focus It is inaccurate to refer to “Dodd- including the CHOICE Act’s spon- especially on three key policy out- Frank” as a single law. It is, in fact, sors in Congress, that this Republican comes that Republicans have sought sixteen different statutes rolled into approach to governance and regula- during the last six years: reforming one. But when Dodd-Frank’s crit- tion will finally get its due. But there the Federal Reserve, overhauling ics point to an overarching zeitgeist, is a problem with this assumption. The the Consumer Financial Protec- it is essentially technocratic: the Act CHOICE Act is a staging ground not tion Bureau, and changing the way puts enormous power in the hands of only for ideological conflict between the largest financial institutions are regulators—whether at the Federal technocratic Democrats and market- regulated. The issues described here Reserve or FDIC, or new agencies like oriented Republicans, but also for are much broader than the CHOICE the Consumer Financial Protection an institutional conflict between the Act, though that proposed legislation Bureau and the Financial Stability executive and Congress. The bill was provides a useful jumping off point Oversight Council—to prevent, man- introduced with the presumption that for discussion. The real questions are age, and resolve abuses of the financial Hillary Clinton would win the presi- about who controls power within the system that can result in crisis. dential election. Much of the language party system: those with ideological The Republican model for reform aimed at limiting the powers of the commitments to specific policy out- is very different. Rather than del- executive can be read through that comes, or those who seek to increase egating to regulators this power, prism. But what does the direction of the institutional power of the Presi- the Republican model would place financial reform under an ostensibly dent. Prior to last November, Republi- more control in the hands of market unified Republican federal govern- can calls for financial reform had been participants themselves and, failing ment look like? And what happens if predicated on a Hillary Clinton presi- that, judges. The defenders of the the new Republican President disap- dency. Now that that has not come to Republican plan for financial reform proves of some of his party’s estab- pass, and Republicans control both would emphasize a light governmental lished views on the 2010 law? the executive and legislative branches, touch and the rule of law. Let market These are the questions for those this Issue Brief reviews a new set of participants allocate risk as makes who would predict a wholesale aban- questions that have arisen as to how most sense to their business model donment of Dodd-Frank. While we the ruling party will pursue its agenda and let them fail when they cannot. cannot be sure of the final shape of with respect to financial regulation. That failure will be resolved by law- a financial reform under a govern- following bankruptcy judges after the ment united by the Republican Party, fact, not fine-tuning central bankers we can be certain that the policy well before. and institutional preferences of the

NOTES

1 For a summary of the CHOICE Act’s key features, see banking regulators,” Washington Post, November 11, files/ryan-pelosi-letter-20151116.pdf. http://nascus.org/publications/NASCUSReport/2016/ 2009. 6 See the transcript of the Meeting of the Federal Open CHOICE%20summary.pdf. 4 Victoria McGrane, “Elizabeth Warren and David Vitter Market Committee, November 1-2, 2011 available at 2 Jesse Hamilton, “Mnuchin Puts Pressure on Banks Over Introduce Fed Legislation,” Wall Street Journal, May https://www.federalreserve.gov/monetarypolicy/files/ Volcker Rule, Glass-Steagall,” Bloomberg, January 19, 7, 2015. Warren (D-MA) and Vitter (R-LA) have jointly FOMC20111102meeting.pdf. 2017. criticized the Fed’s lack of transparency and introduced 7 From the opening lines of a speech delivered by Ben 3 Peter Conti-Brown, The Power and Independence of the a bill to distribute authority and responsibility more evenly Bernanke on November 14, 2007: “Montagu Norman, the Federal Reserve, Princeton University Press, 2016; Rand among Fed governors. Governor of the Bank of England from 1921 to 1944, re- Paul and Mark Spitznagel, “The Fed is Crippling America,” 5 For example, see Janet Yellen’s November 16, 2015 letter putedly took as his personal motto, “Never explain, never TIME, January 10, 2016 ; Binyamin Appelbaum and Brady to House Speaker Paul Ryan and Minority Leader Nancy excuse.” Norman’s aphorism exemplified how he and Dennis, “Legislation by Senator Dodd would overhaul Pelosi available at https://www.federalreserve.gov/foia/ many of his contemporaries viewed the making of mon- 2 publicpolicy.wharton.upenn.edu

Republican President will change that Issue Brief highlights and addresses Legislative proposals, including within ethos. For example, President Trump’s the critical aspects of each of these the CHOICE Act but also predating nominee for Treasury Secretary, Steve three areas, with the acknowledgment it, would insert much more congres- Mnuchin, has already walked back the that other important issues remain sional engagement with monetary idea of doing away with Dodd-Frank outstanding, such as the complexities policy through more transparent in its entirety. During his Senate of the Volcker Rule and the massive rulemaking. House Republicans have confirmation hearing, Mnuchin said growth of the shadow banking system. called for the Fed’s monetary policy that the new administration favors the committee, the Federal Open Market Volcker Rule, which prevents com- REMODELING THE ROLE OF Committee (FOMC), to explain all mercial banks from using depository THE FED of their policy rate decisions in terms assets for making investments not on of a standardized rule and to do so, behalf of a client. As Mnuchin stated, Politicians, activists, academics, and specifically to Congress, within days “The concept of proprietary trading central banks have discussed many of each FOMC meeting. Critics of does not belong in banks with FDIC ways to alter the status quo of the this proposal have wrongly asserted 2 insurance.” This declaration should Fed’s independent monetary policy that this rule necessarily must be the surprise some of Obama’s and Dodd- authority and financial industry Taylor Rule, named for the simple 3 Frank’s longest-standing Republican supervision over the past few years. arithmetic function first devised by critics: repeal of the Volcker Rule has In response to the Fed’s outsized role Stanford economist John Taylor to long been a goal of those critics. in combatting the ill effects of the describe how the Fed conducted Whatever the ultimate direc- financial crisis, there has been a call monetary policy from 1987-1992. The tion that these legislative and execu- for greater transparency and account- original proposals do indeed mandate tive debates take, three major points ability of the Bank’s activities. While that conformity, but the current leg- will be central to any discussion of the Fed has been subject to a variety islative plan would require the Fed to financial reform. These three areas of critiques for the way it has handled choose its own rule and explain why of potential reform are: the Federal the response to financial crises and it deviates from the Taylor Rule, if in Reserve’s operations, particularly as bank supervision generally, the main fact it does. they pertain to how the Fed con- focus—and certainly the place where The Fed has argued—persuasively, 5 ducts monetary policy; the role of the Fed is likely to fight back the in my view—against this proposal. 4 the Consumer Financial Protection hardest —is in the specific ways that Guiding monetary policymaking Bureau; and the process of designating it conducts monetary policy. by a coherent and consistent rule is and regulating large financial institu- Republicans have long criticized not necessarily disadvantageous. The tions as “systemically important” and the Fed for using discretion in con- Fed has embraced this method for thus subject to additional regulatory ducting monetary policy, rather than decision-making, as the recent disclo- constraints. The remainder of this following a rigid, programmatic rule. sures in the 2011 FOMC transcripts

NOTES

etary policy--as an arcane and esoteric art, best practiced regulatory efficacy. This requirement would apply across out of public view.” Available at https://www.federalre- the board to every financial regulatory agency. serve.gov/newsevents/speech/bernanke20071114a.htm. 11 The current proposal does not abolish the FSOC outright, 8 J. Lawrence Broz, “The Federal Reserve’s Coalition in but rather repurposes the entity as an inter-agency forum Congress,” Working Paper, February 2015. on financial stability with a mission that is largely relegat- 9 See the Federal Reserve System Audited Annual Financial ed to market monitoring and information sharing. In that Statements available at https://www.federalreserve.gov/ sense, it mirrors the pre-Dodd-Frank Presidential Working monetarypolicy/bst_fedfinancials.htm#audited. Group on Financial Markets, created by Ronald Reagan in 10 The CHOICE Act goes further by mandating a retrospective 1988. review of all regulations every five years against a pre- determined set of metrics for the purpose of determining 3 publicpolicy.wharton.upenn.edu

6 suggest. And the idea that the Fed the Federal Reserve undergoes a thor- Reserve has funded itself beyond should not be a fortress of techni- ough accounting audit each year, con- appropriations since its founding in cal solitude is a sound one. We are a ducted by a leading accounting firm 1913. The current proposal would long way off from the central banking with topline results disclosed to the exclude the Fed’s monetary policy 9 ethos that dominated the 19th and public. It is also audited by the GAO operations and focus solely on its 20th centuries to “never explain, never in other ways, and has an independent regulatory and financial supervisory excuse,” in the words of one promi- Inspector General that conducts audits activities. In principle, there is justi- 7 nent central banker. and investigations of various activities. fication for this proposal, given how Indeed, the Fed is today one of the Congress has also mandated one-time important the appropriations process most transparent of all governmental audits of specific activities, as it did is to congressional oversight of the institutions. It holds regular press con- in Dodd-Frank in auditing the Fed’s administrative state and how much ferences; its key leaders give speeches emergency lending program. financial regulators have existed out- and congressional testimony. Its min- That leaves the question: what side of that process (in addition to the utes are released after three weeks, and is left for the GAO to audit? The CFPB and the Fed, the Comptroller full transcripts released on a five-year answer is the Fed’s internal monetary of the Currency, the Federal Deposit lag. Mandating monetary policymak- policy deliberations, especially where Insurance Corporation, and some ing by rule will enhance transparency those decisions are controversial. It is other financial regulators are also not in some ways, but it won’t add trans- again understandable that members subject to the appropriations process). parency where none exists. of Congress want to have a tighter The proposal’s defining weak- Perhaps more importantly, trans- grip on the way the Fed conducts ness, though, is that appropriations parency isn’t always an unmitigated itself: the Fed is, after all, a creature oversight is a blunt tool not easily good. When macroeconomic condi- of Congress. But a GAO audit would separated among functions. If it is true tions change, the Fed presently has only increase the level of organiza- that the Fed should have budgetary the flexibility to adjust course, regard- tional complexity within the Fed, independence for the conduct of mon- less of any guiding rule, without already one of the most complex etary policy, then subjecting it to the worrying about triggering searing institutions of government. It would appropriations process for regulatory congressional scrutiny at precisely the also be an easy bludgeon for members matters will only invite congressional time of monetary experimentation. of Congress to litigate their preferred meddling into anything the Fed does A fixed rule, especially one report- approach to monetary politics. Again, that is of political interest to members able to and subject to the oversight by insulating the Fed from the day-to- of Congress. In practice, there may be Congress, could prevent the Fed from day of partisan politics is precisely the no meaningful way to separate super- being able to quickly pivot in response point of independent central bank- visory and regulatory activity from to new information. The alternative is ing. That insulation isn’t a complete monetary policymaking. monetary policymaking by legislative removal—the Fed is still deeply committee, which is an institutional embedded within the political system. OVERHAULING THE CFPB arrangement that independent central But a GAO audit of monetary policy banks are precisely designed to correct. would remove almost all of that insu- The Consumer Financial Protec- A second perennial proposal is lation altogether. tion Bureau began its life as a policy a U.S. Government Accountability A third, newer proposal, subjects proposal by then-Professor Elizabeth Office (GAO) annual audit of the all financial regulatory agencies to Warren, published in Democracy Fed’s day-to-day monetary policy the annual appropriations process. magazine in 2007. Interestingly, the operations. Auditing the Fed enjoys The Consumer Financial Protection “Financial Product Safety Com- a storied, bipartisan history, but it is Bureau’s non-appropriated status has mission” that Warren first proposed important to distinguish an account- long been a source of contention, (or the Consumer Financial Protec- 8 ing audit from a political one. Today, as discussed below, but the Federal tion Agency originally proposed in

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the Frank version of the statute that also be subject to the congressional Senate Republicans sought to avoid became Dodd-Frank) looks very little appropriations process (it is currently by making the CFPB an independent like the final Consumer Financial funded through the Fed), be required bureau of the Fed in the first place. Protection Bureau created by the final to conduct cost-benefit analyses for If the Republicans want to elimi- statute. The differences are at the heart all its regulations, and lose much of its nate the Bureau on the charge that it of what makes the CFPB so contro- enforcement authority. For example, has overstepped its bounds and that versial today. These differences have it would have to consider the safety consumer financial protection regula- little to do with functions and every- and soundness of financial institutions tions hurt consumers more than they 10 thing to do with structure. Function- when promulgating new rules. States protect them, then that merits debate. ally, the CFPB today is very much in and tribes would be allowed to request Deregulation through reregulation line with what Warren, now a Demo- unconditional waivers from CFPB is an inefficient, opaque, and confus- cratic Senator from Massachusetts, regulations governing short-term, ing mechanism for accomplishing the proposed —the CFPB seeks to protect small-dollar credit (i.e., payday loans). same goal. consumers from financial fraud and And the Commission also would no Journalists have tried, in vain, to educate them about financial products longer have the authority to ban prod- get a commitment from the Trump like mortgages, credit cards, and stu- ucts or services it deems abusive. Administration on the CFPB’s future. dent loans. But structurally, the deci- The curious redesign of the CFPB Of all the various aspects of financial sion to render the new governmental prompts the question: why not just reform, the identity and future of the agency a sub-bureau of the Federal abolish the agency altogether? The CFPB will probably be the most con- Reserve headed by a single individual answer probably has more to do with tested fight of the upcoming debate. was not a Democratic idea, but a the optics of that kind of abolition Republican one. Senator Bob Corker rather than policy preference. Given RETHINKING SIFI (R-TN) was a key figure in negotiat- that House Republicans fear the back- DESIGNATION AND ing the Senate version of the bill and lash for being seen on the wrong side REGULATION changing the structural features of the of consumers, abolishing the Bureau CFPB not to insulate it from politi- is not politically feasible, leaving an The third debate, already underway cal oversight, but to quiet conservative overhaul of its organizational struc- and likely to continue, relates to the fears about more and more bureau- ture and elimination of much of its way the federal government regulates cracy interfering with market activity. functional authority as the only way to the nation’s largest banks. The Dodd- The model for the CFPB was the Fed, accomplish those same ends. Frank Act created the Financial not the SEC. The debate the Republicans seek Stability Oversight Council (FSOC) Republican enthusiasm for that to have is a worthy one. Should the to designate bank and non-bank different structure didn’t even last CFPB look more like the SEC, less financial companies as SIFIs and thus through the legislative session that like the Fed? Should the United States subject to greater regulatory burdens created it. The latest proposals would have a CFPB at all? Certainly its bud- meant to prevent their failure. This is effectively abolish the CFPB and getary autonomy protects it from con- the first order of business for Dodd- replace it with a regulatory commis- gressional oversight in a way that most Frank, appropriately located in the sion called the “Consumer Financial agencies don’t enjoy. (See Figure 1 for Act’s Title I. The CHOICE Act, and Opportunity Commission,” given the how the CFPB’s budget per employee likely any future incarnation, would 11 dual mandate to enforce consumer compares to the Fed and SEC.) But repeal most of this authority. financial protection laws (though that debate should be clear on its Under the proposed legislation, the with significantly limited tools for terms. Restructuring the CFPB as an FSOC’s authority to break up large doing so) while enhancing “finan- ambiguously charged independent financial institutions upon the recom- cial opportunity” for individuals and commission would produce precisely mendation of the Federal Reserve businesses, including banks. It would the kind of bureaucratic muddle that would disappear. The Council’s

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FIGURE 1 ANNUAL BUDGET PER EMPLOYEE (IN THOUSANDS) FOR SELECTED financial risk. Purists will continue FINANCIAL REGULATORS, 2011-2015 to lobby for these limits regardless $400 of who holds the office of President, viewing ample executive discretion $300 as the core problem to be corrected. Political strategists, however, who $200 awoke in a Republican-controlled Washington, DC, may start reevalu- $100 ating their priorities. Now that a Republican is President, the great $0 unknown for the future of finan- 2011 2012 2013 2014 2015 cial reform is whether an insulated CFPB SEC FED CFPB with a Trump appointee at its helm is the surest way to effectuate research support arm – the Office of ing a strong Republican consensus, the Republican policy goals, or whether a Financial Research – would be elimi- CHOICE Act eliminates all of Title Trump-dominated Fed is superior to nated. Additionally, the FSOC would II and replaces it with an addition to a rule-bound central bank more likely no longer be able to designate non- the U.S. Bankruptcy Code. When crit- to interfere with Republican fiscal banks as SIFIs, and all of its previous ics have said they hope to repeal the priorities, or a regulatory apparatus designations of non-bank financial Dodd-Frank Act, they are sometimes dominated by sympathetic personnel is companies (e.g., AIG, Prudential, and speaking of precisely this proposal. indeed preferable to a system with less MetLife) would be invalidated. This Some of the ablest experts on of that kind of partisan control. And, includes clearinghouses for derivatives Dodd-Frank view Title II as creating of course, much of the outcome on – one of the very few aspects that both an institutional framework that will these policies will be driven by Trump Republicans and Democrats lauded effectively guarantee further 2008- himself. The White House is divided in the 2010 law. And even those large style government interventions in between those, like the Secretary of banks that Republicans agree could market processes. But it is not at all the Treasury-designate, who are old threaten the stability of the financial obvious that so-called Article I judges hands on Wall Street and those who system could make a few changes are a superior approach. Bankruptcy reflect more of a populist suspicion to their capital structures and avoid judges are not experts in banking, and of that very authority. It is on three most of the regulatory framework that may be too inclined to treat bank debt key issues – the Fed’s role as a central Dodd-Frank created. as they would any other corporate bank and financial regulator insulated If Republicans have shown reorganization. There may be benefits from Congressional oversight and the discomfort with Title I, they have to letting Dodd-Frank test its mettle appropriations process; the CFPB’s wholesale disregard for Title II. Title before handing over all liquidation governance structure and broad II recognizes that the regulatory authority to courts. authority; and the designation and efforts to prevent the largest banks regulation of SIFIs – that the most from failure will not always work and CONCLUSION important piece of financial legisla- provides a second, regulator-focused tion in decades, the Dodd-Frank Act, process whereby the largest banks are The Republican vision of financial will be affirmed, amended, or rejected. resolved through an “orderly liquida- regulatory relief over the last six years Each path has enormous ramifications tion” rather than either a messy bailout has been focused on limiting the for the health and stability of the U.S. or a catastrophic bankruptcy. Reflect- executive’s discretion in response to financial system.

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ABOUT THE AUTHOR

PETER CONTI-BROWN, JD Associate Professor of Legal Studies & Business Ethics, The Wharton School

Peter Conti-Brown is an assistant professor at the Wharton School of the University of Pennsylvania. Prior to joining Whar- ton, he was an academic fellow at the Rock Center for Corporate Governance at Stanford University from 2010-2015. A financial historian and a lawyer, Conti-Brown studies central banking, financial regulation, and public finance, with a particular focus on the history and policies of the US Federal Reserve System. He is author of the book The Power and Independence of the Federal Reserve (Princeton University Press 2016), the editor of two other books, and author or co-author of a dozen articles on central banking, financial regulation, and bank corporate governance. He holds degrees from Harvard College, Stanford Law School, and Princeton University’s Department of History. He is currently at work on a single-volume, comprehensive political and institutional history of the US Federal Reserve, under contract with Harvard University Press.

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