The man who would repeal and replace Dodd-Frank

(Bloomberg View) — Representative Jeb Hensarling, a Texas Republican who wants to overhaul financial regulation, is under consideration to be Donald Trump’s Treasury secretary.

Even if the job goes to someone else (hedge-fund manager Steve Mnuchin appears to be the front-runner), Hensarling’s chairmanship of the House Financial Services Committee will give him vast influence over Wall Street next year.

He and Trump believe the 2010 Dodd-Frank Act has kept banks from lending and the economy from growing. They want to repeal and replace it, to borrow a favorite Republican phrase. But the congressman’s replacement bill, which has several good deregulatory ideas, would go too far by reversing changes that have made the banking system safer.

See also: Bill to replace Dodd-Frank passes House panel

QuickTake: The Volcker Rule

Dodd-Frank, one of President Barack Obama’s signature achievements, was supposed to make sure that a financial crisis like the one in 2008 never happens again. But even staunch supporters of the law concede that some of Hensarling’s deregulatory ideas make sense.

The 2008 crisis was caused mostly by bank regulators’ failure to see dangerous risks building in the mortgage-finance business. Among other things, Hensarling would relieve smaller banks of many of the law’s arcane rules, which were meant to rein in the biggest, riskiest money-center institutions, not tiny community banks.

He would also lighten supervision of large banks whose ratio of capital to assets is at least 10 percent. While the ratio probably should be higher — at least 15 percent and preferably 20 — Hensarling has the right idea: The best way to guard against a system-wide crash is by requiring banks to have large amounts of loss-absorbing capital (the money that comes from shareholders and retained profits).

The average ratio for the largest U.S. banks is currently 5.75 percent (using international accounting measures). This means they would all be insolvent if their assets collectively lost just 5.75 percent of their value. Such a scenario is not far-fetched: In 2008, banks needed government assistance equal to about 6 percent of assets. Under Hensarling’s bill, the riskiest banks would have to roughly double the amount of capital they now have — a positive development. The head of the Minneapolis Federal Reserve Bank, Neel Kashkari, today called for large banks to have 23.5 percent capital.   

Hensarling’s proposed changes to the structure of the Consumer Financial Protection Board are also probably necessary. An appellate court in October called the bureau “unconstitutionally structured” because the president can’t replace its executive director except for malfeasance, and its funds come not from congressional appropriations but through the Federal Reserve.

The unusual structure has insulated the agency from Wall Street lobbyists, yet it probably fails the Constitution’s separation-of-powers test. Hensarling would impose the usual checks and balances by putting the bureau under a five-member bipartisan commission, like other regulatory agencies, and requiring it to get its funds from Congress.

But overall, the Texas congressman’s bad ideas outweigh the good ones. Some of the Dodd-Frank law’s essential pieces — the stuff Wall Street most despises — would be undermined, leaving the financial system dangerously exposed.