Dodd-Frank’s Legacy of Community Bank Destruction

Hillary Clinton loves to talk tough about reining in the big “Wall Street” banks. She also loves to wax poetic about the small, “Main Street” banks that were once a bedrock of communities.

“Today, local banks are being squeezed by regulations that don’t make sense for their size and mission—like endless examinations and paperwork designed for banks that measure their assets in the many billions,” Clinton told a crowd in May. “And when it gets harder for small banks to do their jobs, it gets harder for small businesses to get their loans. Our goal should be helping community banks serve their neighbors and customers the way they always have.”

Dare I say it? She sounds like a Republican.

The problem is that she doesn’t act like a Republican. Instead, she praises small banks with shouts while whispering that she’ll also defend, and even “go beyond” the regulations that led to small banks demise.

The biggest example is Dodd-Frank, a bill that promised to end “too big to fail,” but ended up only enshrining it into law. A quick look at two statistics is enough to tell the story: Currently, the five largest banks control nearly half of the nation’s banking wealth, but in 1990, the five biggest banks controlled just 10 percent of the industry’s assets. And, only one new bank has opened in the five years since Dodd-Frank passed, compared with an average of 100 new banks that were opened in an average year in the three decades prior. One bank in five years. That’s it.

That’s exactly the opposite outcome that Washington should have been aiming for. After all, community banks weren’t engaging in the types of questionable investing behavior that served as kindling when the housing crisis set the banking industry aflame. They weren’t covering up their risk by blending tranches of questionable home loans through mortgage backed securities and collateralized debt obligations. They weren’t hedging their bets with derivatives and proprietary trading to cover any losses. And they certainly weren’t angling to profit off the inevitable collapse they were fueling by throwing money at credit default swaps. Instead, they made a disproportionate share of agriculture, small business, and traditional residential mortgage loans.

That’s largely why community banks were able to emerge from the financial crisis relatively unscathed, only to find that law the Democrats’ passed to purportedly fix the problem would be enough to irreparably damage many community institutions. As Marshall Lux and Robert Greene found:

Community banks…withstood the financial crisis of 2008-09 with sizeable but not major losses in market share – shedding 6 percent of their share of U.S. banking assets between the second quarter of 2006 and mid-2010, according to this working paper’s findings. But since the second quarter of 2010, around the time of the Dodd-Frank Wall Street Reform and Consumer Protection Act’s passage, we found community banks’ share of assets has shrunk drastically – over 12 percent.

This is a disastrous outcome with effects that will ripple throughout the economy for decades to come. Community banks, as their name indicates, are one of the most important institutions in their communities. They succeed not because they have a Harvard educated, green-eye-shade wearing accountant who is making and hedging bets to guarantee the bank makes money whether or not the borrower pays or defaults. No, they succeed because they have a personal relationship with the person they’re lending money too. They know someone’s family structure, work history and payment records not because they filled out a form, but because they talked about it at church on Sunday. And it’s worked. A recent report found that since 2009, mortgages at community banks default at a rate of less than a quarter of a percent – about one-fifteenth the overall rate.

But when community banks are forced to comply with thousands of hours of new regulation and red tape they simply can’t do business the same way, they’re either forced to only offer bigger loans or opt to close their doors. Federal Reserve Board Governor Daniel Tarullo explains why this is a problem:

“This state of affairs is not surprising when one considers that credit extension to smaller firms is an area in which the relationship-lending model of community banks retains a comparative advantage. It means that community banks are of special significance to local economies. It also means that, particularly in rural areas, the disappearance of community banks could augur a permanent falloff in this kind of credit, at least a portion of which may not be maintained in the more standardized approach to lending, characteristic of larger banks.”

In other words, not only do we get fewer small banks setting up shop in communities, it means we have less aggregate ability to serve the entrepreneurs and small businessmen who have been the backbone of job creation for so long. Is that really the outcome that Hillary Clinton wants? If not, she needs to start talking about rolling back, not expanding, Dodd-Frank.


Cover image courtesy of www.SeniorLiving.Org