WASHINGTON, February 4, 2017 — Along with numerous other initiatives implemented during in his first few weeks in office, President Trump wants to roll back much of the Dodd-Frank law. Passed by Congress, this complex, draconian body of regulations and Federal oversight was designed to reign in the financial excesses of banks, investment banks and other financial institutions that largely ignited the Great Recession.
Trump’s opponents claim he is transparently attempting to pad the pockets of his banker friends by gradually dismantling Dodd-Frank. In reality, America’s new President actually wants the economy to end the below 3 percent growth slump that the U.S. has endured since roughly 2005.
Passed by Congress in 2010, Dodd-Frank was strongly supported by both the Democrat-controlled House and Senate and quickly signed by President Obama. The law’s supporters felt strongly that the financial crisis was due to big banks taking advantage of consumers by encouraging them to take on mortgages they simply could not afford.
Supporters of Dodd-Frank claimed that banks were guilty of predatory lending practices when they used unscrupulous tactics to lure unqualified borrower to take on home loans that were structured to allow the lender to earn higher fees. It all worked out just fine until it didn’t. The banks originated the loans, earned the fees, then sell the mortgages to another entity usually the then-quasi-public companies Fannie Mae or Freddie Mac, both of which are now essentially in Federal receivership.
Dodd-Frank was designed to put an end to the kind of predatory lending that lay at the heart of the Great Recession. The problem was the law was so restrictive it effectively put an end to normal, customary and safe lending practices, particularly when it came to the middle class and small businesses.
Dodd-Frank unwittingly created a new system in which individuals and small businesses couldn’t obtain financing to fund expansion and growth. It also meant that monetary policy would be less effective. The real truth behind the 2008-2009 financial crisis was that it was not actually caused by predatory lending in and of itself. Instead, the Great Recession was the direct result of the Federal government’s interference in the housing market and its encouragement of lenders to offer the kind of low-quality loans that would prove popular with lower income families, encouraging them, essentially, to buy home they were not really qualified to buy.
In the late 1980s, sociologists began to convince Congress that social problems like crime, low high school graduation rates, drug usage and teenage pregnancies are minimized in communities where people own homes rather than renting them. To minimize social problems, they said, the U.S. should alter lending policies to increase America’s home ownership rate, which was historically in the range of 62 to 64 percent of households.
Congress set a goal to raise the rate to 70 percent, a rate that was achieved in 2005. That meant about 8 percent of households—roughly 10 million—were converted from renters to owners by qualifying for an average mortgage of $200,000, for a total of $2 trillion in loan value.
The reasons those 10 million households were renters and not owners, however, was the simple fact that they did not have enough money for a down-payment, nor did their income allow them to afford their monthly mortgage payments.
Due to irresponsible government policy, Fannie Mae, Freddie Mac and other large mortgage holders said they would buy mortgages from banks, even when borrowers put little or nothing as a down payment and only qualified for the mortgage because the initial or “teaser” interest rate was very, very low, though such rates were set to rise over time, presumably as the borrowers’ income rose. This, the government theorized, would allow 10 million renters to become owners.
Banks and other lending institutions began to offer these types of mortgages. Once the renting public found out that they could own a home with no down payment and have a monthly mortgage payment less than they were paying for rent, they flocked to the banks in record numbers. While it is true that banks made these loans preimarily to earn large initial fees, that is exactly how they operated for decades.
But previously, housing loans were made only to qualified buyers–those buyers whose income and personal finances would clearly allow them to be repaid over time. The banks granted the new “predatory” loans to less qualified borrowers precisely because they were encouraged by government policy to do so. And with that encouragement and support, that’s also what they could sell to the final mortgage holders.
Over time, however, the growing number of adjustable rate mortgages on the books caused individuals’ monthly payments to rise faster than their incomes were rising. That, coupled with declining real estate values once the housing bubble popped caused almost all subprime mortgage holders to default on their mortgage loans. The resulting $2 trillion default is what caused the financial crisis.
Dodd-Frank has supposedly put an end to such a scenario, imposing severe restrictions on banking institutions’ ability to lend. Incredibly restrictive lending rules made it nearly impossible for many businesses to secure debt financing. But without bank lending, there is no multiplying effect, no increase in the money supply available to the public. Without this “velocity of money,” there can be little if any growth. That’s why the money supply tripled during the the Federal Reserve Bank’s quantitative easing (QE) programs, yet failed to ignite inflation nor led to economic growth.
Large corporations and wealthy investors were able and qualified to borrow this virtually free money at historically low interest rates, using it to float loans at absurdly low interest rates, and inject money into the stock and bond markets, driving the historic post-Great Recession bull market that has continued to this day. But at the same time, small businesses and middle-class individuals were closed out of the action, often no longer able to qualify for loans under Dodd-Frank.
Businessperson President Trump understands how the business world works and how the business mind thinks. He has set economic growth as a priority for his administration. One way to encourage growth is to allow banks the ability to make loans to growing businesses, not just to wealthy individuals and large corporations. Repealing most of Dodd-Frank and returning more discretion to the banking industry will spur the economic growth the country sorely needs.
Trump is right on this one. It is high time to repeal and/or replace most of the disastrous Dodd-Frank law.
*Cartoon by Branco. Reproduced with permission and by arrangement with LegalInsurrection.