A $110 Billion Black Hole Explains the Sorry State of Financial Regulation

A Black Hole

by Sean Hackbarth, Contributing Author: A recent Wall Street Journal story epitomizes the sorry state of U.S. capital market regulation. Following the bursting of the housing bubble, regulators claimed nearly $110 billion in fines and settlements [subscription required] from financial institutions.

Where did the money go? WSJ reporters did their best Stephen Hawking impression and found that much of it fell into an unaccountable black hole [emphasis mine]:• The Treasury Department received almost $49 billion of the funds, including money the agency received directly and sums funneled to it by other departments, including government-chartered housing associations Fannie Mae and Freddie Mac. How the money is spent isn’t specified.

• About $45 billion was earmarked for “consumer relief,” a category that includes money dedicated to helping borrowers and funding housing-related community groups.

• The Justice Department, whose prosecutors led many of the negotiations with banks, collected at least $447 million. How it spends the money isn’t specified.

• States received more than $5.3 billion, usually to spend as they saw fit. Almost all states received payments from a national settlement in 2012 over mortgage-servicing abuses, and seven also received payments in the Justice Department’s blockbuster mortgage-securities settlements that started in 2013.

• Roughly $10 billion went to other recipients, including housing-related federal agencies, two federal agencies responsible for cleaning up failed banks or credit unions, and whistleblowers who helped the Justice Department. Some funds from these deals typically revert to the Treasury.Fines that went to New York State government fund improving the New York State Fairgrounds' concert stage and horse barns.

In short: Billions of dollars went into a slush fund for government officials to spend as they wish and for politicians to earn good headlines for “doing something.”

While officials patted themselves on the back for satisfying a populist itch, they have created a complex financial regulatory monstrosity that saps energy from the U.S. economy and impedes economic growth.

Tom Donohue, U.S. Chamber president and CEO, spoke about financial regulation at the 10th Annual Capital Markets Summit:When we talk about capital markets, we are talking about banks, stock exchanges, bond markets, mutual funds, angel investors, venture capital, private equity, consumer financial products—any form of financing a business needs to grow and operate.

From the entrepreneur who is applying for a home equity loan, to an emerging growth company that is going to issue an IPO, to a multinational company seeking to execute a letter of credit for a trade deal—each relies on efficient capital markets.Capital is the fuel of free enterprise, and capital markets pumps that fuel to the engine of economic growth.

When capital markets aren’t functioning well, new office space isn’t built; new factories aren’t built; tools and equipment to fill those offices and factories aren’t purchased; new stores aren’t opened; economic growth is constrained.

But when they are effectively moving capital to productive uses, capital markets spur innovation, job creation, and economic opportunity.

However, ever since the 2008 financial crisis, capital markets have been under siege by regulators, and financial companies have become political punching bags.

Said Donohue, “Many legislators, policymakers, and regulators, regardless of party or ideology, see our financial services providers as a problem to be solved, limited, and controlled—and not a key ingredient to boosting the economy.”

By building a regulatory regime on “a creaky foundation,” policymakers have trapped financial institutions in a “no-win regulatory, business, legal, and political environment,“ Donohue proclaimed:Too often they are told to lend, but also sock away more capital. They are asked to plan for a doomsday scenario, but aren’t allowed to manage cash for a business.

Increasingly, “political risk” and “regulatory risk” are replacing “credit risk” as a driver of what services banks and other financial intermediaries are able to provide.

In too many instances, rules are designed to cover regulators’ backs and not to promote a well regulated market.

As a result, financial service providers are afraid to launch new products because they are out of regulatory favor, or they stop offering existing products because compliance becomes too cumbersome or costly.One example is the Labor Department’s attempt to reform fiduciary standards. Unless changes are made, the proposed retirement rule will hurt the middle class savers it’s intended to help. “If they don’t get the rule right, up to 9 million small business owners could stop providing retirement benefits to their employees,” said Donohue.

Business leaders experience these regulatory problems first-hand.

“The regulatory world has changed substantially,” said Walter Bettinger, Charles Schwab’s president and CEO, in an interview at the capital markets summit. Various federal agencies are “all trying to regulate the same thing at different times.” Staff is overwhelmed “in a perpetual cycle of serving the regulators.”

Under the expansive, regulation environment in place today, there would be “no possible way” to start a kind of business like Charles Schwab today, said Bettinger.

A rational, sensible financial regulatory environment can mean the difference between a low growth, low wage economy versus one that grows faster and produces more jobs and economic opportunity.

“If we get the policies right, then our capital markets are poised to provide capital to startups and businesses and to serve consumers,” Donohue explained.

The choice is ours.

What will the financial world be like in 2026? Read Finance Flash Forward — a collection of essays compiled by the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness.
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Sean Hackbarth is a policy advocate and Senior Editor, Digital Content, at U.S Chamber of Commerce. He twitters at @seanhackbarth and is a contributing author at the ARRA News Service.

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