House Financial Services Committee Chairman Jeb Hensarling (R-Tex) has offered the first look at a comprehensive Republican plan to promote economic growth by replacing the Dodd-Frank Act. In a speech before the Economic Club of New York, Hensarling sketched the contours of the forthcoming Financial CHOICE Act, which he labeled a “new legislative paradigm” for banking and the capital markets that will allow strongly capitalized banks to opt-out of burdensome regulations, end too-big-to-fail, and impose greater accountability on regulatory agencies. The plan also would repeal Dodd-Frank’s controversial Volcker Rule while instituting a raft of proposals for fostering capital formation.
Hensarling said the full text of the Financial CHOICE Act, which stands for Creating Hope and Opportunity for Investors, Consumers and Entrepreneurs, will be released by the Republicans later this month. Democratic lawmakers blasted the plan as outlined in the speech, however, denouncing it as a “special interest wish list” that would weaken financial and consumer protections while giving Wall Street a “get out of jail free” card.
“Grave mistake.” Hensarling called the Dodd-Frank Act a “grave mistake” foisted by Washington upon the American people. Noting the mere one percent growth in GDP in the last quarter, Hensarling said that instead of lifting the economy as supporters had promised, Dodd-Frank has stifled entrepreneurship and economic growth while codifying into law too-big-to-fail and taxpayer-funded bailouts. In the Chairman’s view, “we need economic growth for all and bank bailouts for none.”
Dodd-Frank off ramp. Hensarling said that the Financial CHOICE Act rests on the belief that bank capital is the most basic element in a healthy and resilient financial system. Although U.S. banks have raised hundreds of billions in new capital since the financial crisis, capital standards that were already complex have become even more complex with the latest iteration of the Basel capital accords, Hensarling said. In the place of these “growth-strangling” regulations, the Republican plan will offer financial institutions a “market-based, equity financed Dodd-Frank off-ramp” in exchange for meeting higher, yet simple, capital requirements.
Under the Financial CHOICE Act, banks maintaining a simple leverage ratio of at least 10 percent and having a composite CAMELS rating of 1 or 2 would be able to opt-in to an alternative regulatory regime that exempts them from the Basel III capital and liquidity standards and the post-Dodd-Frank supervisory regime. Banks that qualify under the plan would also be able to make capital distributions freely and would be able to consummate transactions without being subject to regulatory challenges on the grounds of increasing risk to the stability of the banking or financial system.
“In short,” Hensarling said, “a strongly capitalized qualifying bank will be enabled to remove government bureaucrats from its boardroom and lend and invest freely.” No bank, however, will be forced to raise new capital. Rather, banks will opt into the alternative regulatory regime only if it makes them more competitive, according to Hensarling.
Ending too-big-to-fail. Hensarling stated that another key part of the Republican plan will be to end too-big-to-fail once and for all by using bankruptcy, not bailouts, to address the failures of large, complex financial institutions. Contrary to the “break up the banks” rhetoric heard on the campaign trail, the goal should not be to downsize or super-size banks but to “right-size” them under market dynamics, Hensarling said. In Hensarling’s view, both Citibank in New York and City Bank in Forney, Texas, play a vital role to play in revitalizing economic growth.
To that end, the Republican plan incorporates the Financial Institution Bankruptcy Act, a bill recently passed by the House to create a new subchapter of the Bankruptcy Code to specifically address failures of large financial institutions. In addition, the plan would prohibit the use of Treasury’s Exchange Stabilization Fund to bail out a financial firm or its creditors and would impose significant new constraints on the Federal Reserve’s emergency lending authority. Finally, the Republican reform plan would repeal the FSOC’s authority to designate systemically important financial institutions (SIFIs) as such designations tend to become self-fulfilling prophecies, Hensarling said.
Regulatory accountability. In order to impose greater accountability on Washington, the Financial CHOICE Act will ensure that every financial regulation passes a rigorous cost-benefit test, Hensarling said. In addition, all the financial regulatory agencies will be placed on budget so that Congress may control the power of the purse. Although the Federal Reserve’s prudential regulatory and supervisory activities would now be subject to the normal congressional appropriations process, Hensarling stressed that the plan preserves the Fed’s independence in conducting monetary policy by leaving that function off-budget.
The plan will also seek to hold Washington accountable by converting the financial regulatory agencies presently headed by single directors—the CFPB, the Office of Comptroller of the Currency, and the FHFA—into bipartisan commissions. This structure will compel those agencies to consider multiple viewpoints in their rule-makings and protect them from partisanship, Hensarling said.
The plan also aims to return Article 1 lawmaking back to Congress through incorporation of the REINS Act, a bill passed by the House last July which requires all major financial regulations to first be approved by Congress before they can take effect. Finally, Hensarling said that the Republican plan would repeal the Chevron doctrine requiring judicial deference to financial regulatory agencies’ interpretation of the law. Hensarling branded the Chevron doctrine as “unfair” and an “affront to due process and justice.”
Tougher penalties and increased due process rights. In an effort to increase the accountability of industry, Hensarling said that the Republican plan would impose the “toughest penalties in history” for financial fraud, self-dealing, and deception. The Financial CHOICE Act will double the cap for the most serious securities law violations and will allow for triple monetary fines when penalties are tied to illegal profits. In addition, the SEC would be granted new authority to impose sanctions more closely linked to investor losses and increase punishments for repeat offenders.
The increased penalties, however, would also be accompanied by increased due process rights, Hensarling said. Among other things, the plan will provide an immediate right of removal to federal court for respondents in administrative proceedings, and all disciplinary proceedings will become public.
Volcker Rule repeal. Labeling it a “solution in search of a problem,” Hensarling said that the plan would repeal the Volcker Rule, which generally prohibits banks from engaging in short-term proprietary trading of securities and derivatives. Hensarling observed that not one of the approximately 450 financial institutions that failed during the financial crisis failed because of proprietary trading. In fact, financial institutions which varied their revenue stream were better able to weather the storm. Not only was the Volcker Rule was misguided and unnecessary, but it has also made the capital markets less liquid and fragile and undermined financial stability, Hensarling said.
Capital formation proposals. The plan also proposes a laundry list of "pro-growth" measures, including the exemption of all asset classes except residential mortgages from mandatory risk retention; the expansion of the Sarbanes-Oxley 404(b) auditing exemption for smaller public companies; and the elimination of disclosures mandated by Dodd-Frank concerning extractive resources and pay ratios. In addition, the plan would give the SEC the authority to register venture exchanges for the listing of JOBS Act companies; provide broker-dealers with the legal certainty to issue research on exchange traded funds; increase the pool of accredited investors; and ensure that startups can meet with angel investors without running afoul of the securities laws.
Democratic response. Ranking Member Maxine Waters (D-Cal) lambasted the proposal, however, accusing the Republicans of refusing to acknowledge that the financial crisis was caused by reckless Wall Street behavior and an inadequate regulatory regime. In a news release, Waters said that the plan "fakes a step in the right direction" by proposing higher bank capital ratios, but "immediately takes two steps backward" by dismantling the FSOC, eliminating the Volcker Rule, and subjecting bank regulators to the appropriations process. “The Chairman’s proposal takes a page from Donald Trump’s casino playbook by gambling with the American economy,” Waters said. “We cannot allow Republicans to take us back to the depths of the financial crisis by weakening regulatory oversight and giving banks the tools to game the system once again.”
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