Financial Reform Can Make the U.S. Stronger


America’s capital markets appear poised to emerge from the pandemic in surprisingly good shape: Stocks are buoyant, credit is flowing freely, and banks are reporting record profits. Could it be that country’s financial system, which performed so poorly in and around the subprime-lending bust of 2008, is now so healthy and resilient that reform is no longer necessary?

Far from it. If anything, the coronavirus crisis has shown how much remains to be done.

Even before Trump came into office, and after the work of the 2010 Dodd-Frank Act, the U.S. financial system still had weaknesses. Banks had more loss-absorbing capital, but not enough to survive a severe crisis. Some of the largest lacked an adequate grasp of what they were doing on any given day. Risks were proliferating outside traditional banks — in corporate, mortgage and auto lending, and in run-prone money-market mutual funds. Regulators didn’t have the data they needed to explain “flash crashes” or even know what was going on in stock, bond and derivatives markets. Millions of Americans, disproportionately poor and minorities, remained unbanked and subject to all manner of financial predation.

The Trump administration failed to address these issues and in many ways made things worse. It weakened the Federal Reserve’s stress tests, designed to see if banks were sufficiently capitalized to weather a financial storm. It hollowed out the Volcker Rule, intended to curb speculation at taxpayer-backed banks. It undermined the Financial Stability Oversight Council’s ability to identify and address risks arising outside banks. It all but dismantled the Consumer Financial Protection Bureau, and reversed efforts to curb predatory behavior in areas including payday lending and investment advice. It undercut rules intended to ensure that all Americans have fair access to credit and financial services.

When the pandemic came, the financial system was ill-prepared. As soon as the scale of the threat became apparent, the short-term lending that keeps financial institutions and much of corporate America running came to a halt: Americans hoarded cash and fled any investments that seemed the slightest bit risky. Bank stocks plunged, borrowing costs soared, non-bank mortgage companies buckled and redemptions drained money-market funds. Only thanks to the swift and unprecedented response of Congress, the Treasury and the Federal Reserve — which pledged trillions of dollars to backstop just about every kind of lending and to support consumers — did banks escape overwhelming losses and the system avoid a collapse.

No doubt, such an extreme economic shock would have demanded a government response under any circumstances. But a stronger system would need less drastic treatment in emergencies. New pressures on financial stability are apt to arise at short notice or in unexpected ways. The current policy of exceptionally low interest rates has driven asset prices higher, and the eventual unwinding of this process could be troublesome. The role of new financial platforms in driving market manipulation and speculative excess —witness the GameStop surge — is another novel hazard. Systems that are fundamentally strong can handle such stresses more confidently. They’re also better at discharging their main economic function, which is to promote broadly based prosperity.

Here’s what the Biden administration needs to do.

  • Build resilience. Require banks and all relevant financial institutions to have ample equity capital, such that stress tests and government bailouts would be necessary only in extremely rare circumstances. Revive the FSOC and empower it to address weak links wherever they might arise. Fix the flaws in money-market funds that make them vulnerable to runs. Redouble efforts — such as the Consolidated Audit Trail and the Basel risk reporting standards — to provide executives and regulators with the information they need to see risks, identify market-disrupting conduct, and anticipate new dangers to the markets’ integrity.
  • Protect consumers. Reinvigorate the CFPB, provide it with clear authority over all consumer financial services (including auto lending) and reinstate initiatives reversed under Trump — such as the bureau’s efforts to end mandatory arbitration and curb the predatory aspects of payday lending. Address abusive debt collection practices, give people more control over their credit records and regulate bank overdrafts as a form of credit. Restore and expand the Labor Department’s fiduciary duty rule, to ensure that all providers of financial advice put their clients’ interests first.
  • Promote equity and fairness. Expand efforts to make a reliable, inexpensive bank account accessible to all Americans. Provide regulators and the public with the data and powers needed to ensure that financial institutions comply with fair lending laws. Correct bias in credit scoring algorithms. Increase federal investment in initiatives — such as the Community Development Financial Institutions Fund and the Small Business Administration’s microloan program — aimed at delivering credit to underserved groups.

Biden’s appointments to the Treasury and to financial regulatory agencies suggest that the president broadly shares these goals. That’s encouraging. These reforms need to happen.

Editorials are written by the Bloomberg Opinion editorial board.

©2021 Bloomberg L.P.

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