House Republicans passed a bill last week in an attempt to shift the way Wall Street is currently regulated. Titled "The Financial Creating Hope and Opportunity for Investors, Consumers and Entrepreneurs Act," or "Financial CHOICE Act," Republicans sought to roll back regulations implemented in the Dodd-Frank Wall Street Reform and Consumer Protection Act by President Barack Obama in 2010. The Act hopes to dismantle the Consumer Financial Protection Bureau, prioritize "legitimate shareholders" who own 1 percent or more of a company's stock, and shift the responsibility of producing "clear and convincing evidence" from banks to shareholders in the judicial system.
In order to understand the severity of this Act, it is important to understand the context of Dodd-Frank regulations. When talking about the Financial CHOICE Act, Republican Rep. Jeb Hensarling of Texas stated that: "Somebody has to protect consumers, not just from Wall Street but protect them from Washington as well. And the Consumer Financial Protection Bureau has hurt consumers. Free checking at banks has been cut in half. Banking fees have gone up. Working people are finding it more difficult to get mortgages. The bottom line is the best consumer protection are competitive, innovative markets that are transparent." What Rep. Hensarling fails to acknowledge, however, was that it was those mortgages and lack of transparency that triggered the 2008 economic crash and recession.
Mortgages were being distributed by all who sought them, without taking into account an individual's credit score or ability to pay back exorbitantly high interest rates. After the collapse of the housing bubble, housing-related securities such as mortgage-backed securities were rapidly devalued due to factors such as mortgage delinquency and frequent foreclosures; these were a direct result of providing loans to individuals who would not have been able to pay them back, also known as "predatory loans." These subprime mortgages resulted in a decrease in banks' net worth, and they began to bundle these loans into Mortgage-Backed Securities (MBS) and Collateralized Debt Obligation (CDO) to increase their rating and appeal to foreign investors. Mortgage-Backed Securities had previously been known as one of the safest and most stable investments before the financial crash was triggered, because of the substantial foreign investment in the American market, the crisis spiraled into one with international consequences.
The purpose of Dodd-Frank was to increase transparency and provide greater protections to consumers from banks that had been considered "too big to fail." It requires banks to report to the Financial Stability Oversight Council (FSOC) which is chaired by the Federal Reserve, create a course of action for rapid and orderly shutdown if a bank is deemed insolvent, and prohibits banks from owning, investing, or sponsoring hedge funds, private equity funds, or any proprietary trading operations for their own profit under the Volcker rule-to name just a few key components of Dodd-Frank.
The Financial CHOICE Act, though it is being presented as a means of protecting consumers, is ultimately dangerous for both shareholders and others who are entangled in the banking system, oftentimes through loans. For example, the Act would reduce the number of tests banks would be subjected to: the Federal Reserve currently relies on an annual Comprehensive Capital Analysis and Review (CCAR) to gauge the stability of a bank should another financial crisis occur. The Financial CHOICE Act would reduce the number of CCARs required from once per year to once every two years. Federal Reserve Chair Janet Yellen referred to CCARs as the "cornerstone of our effort to improve supervision," and the "key part" of the regulatory process.
This Act would also prioritize shareholders with more substantial investments in a company. As the law currently stands, companies are beholden to shareholders who own $2,000 or more in stock for a year or more in order to be allowed a proposal on a proxy ballot. This currently allows a wider range of individuals to have a say in the goings-on of a company; while it is rare that their proposals will receive enough votes to pass, they have the opportunity to make those suggestions. The Financial CHOICE Act would increase the minimum required to allow for proposals: a shareholder would need to own a minimum of 1 percent of a company's shares for three years or more in order to submit a proposal. As emphasized in the New York Times: "One percent may not sound like much, but it can be enormous. Consider Exxon Mobil. It has 4.2 billion shares outstanding, so the 1 percent threshold would mean an investor would have to own 42 million shares, worth $3.4 billion, to be able to submit a proxy proposal."
Gutting Dodd-Frank and removing power from shareholders sets us up for another potential financial crisis. The Act still needs to pass through the Senate, though the vote has not yet been scheduled.