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May 2, 2017

The CHOICE Act: Sowing the Seeds of the Next Financial Crisis

The Financial CHOICE Act is a radical and dangerous deregulation of Wall Street at a time when too much of America is still recovering from the devastating impact of the 2008 financial crisis. The CHOICE Act’s ”trust-but-don’t-verify” stance toward Wall Street is precisely the wrong approach to take with an industry that has repeatedly shown it will use over-leveraged, risky trading strategies to maximize short-term profits, regardless of the impact on the country’s economic stability or taxpayers’ wallets.

The CHOICE Act would allow banks to opt-out of significant financial protection rules, while those banks that remain in the regulatory system would be blessed with watered down versions of once-tough protections like living wills and stress tests. Perhaps most worryingly, the CHOICE Act would cripple one of the most-important post-crash reform: the Financial Stability and Oversight Council (FSOC).

Allowing Banks to Opt-Out of Sensible Financial Protection Rules

The CHOICE Act allows Wall Street banks to opt-out of some of the most important post-crash financial protection rules. In exchange for maintaining a 10 percent quarterly leverage ratio, which is only modestly higher than the range many of these banks maintain today, even the biggest of the Wall Street banks could choose not to be subject to many of Dodd-Frank’s most important provisions.  Remember that the capital shortfall of the biggest banks in 2008-2009 was about 20%, and that was after the government and taxpayers de facto nationalized the financial system with massive bailouts.  Thus, even if banks were required to maintain 10 % real capital, they would still be 100% short of what they would need to survive a crash similar to 2008.

Watered Down Wills and Stress-Free Stress Tests

Dodd-Frank requires the Federal Reserve conduct annual “stress tests” to gauge the health of large U.S. banks. All banks with more than $10 billion in assets are required do their own stress tests twice a year, while “systemically important financial institutions,” including banks with assets over $50 billion, must undergo a separate stress test, run by the Federal Reserve.

The Fed’s stress tests are one of the most effective tools regulators have to prevent a future financial crisis. Even Gary Cohn, Chair of the National Economic Council, acknowledged this when he was the President of Goldman Sachs: “We’re subject to enormously robust stress tests here in the United States, and I give the Fed enormous credit for what they’ve done in stress testing the major banks here in the United States.”[1]

The CHOICE Act would slash in half the number of stress tests for most banks, and require regulators to publicly disclose exactly how the tests would be evaluated, effectively giving the banks a road map to passing the test.  The bill would also block regulators from objecting to a bank’s capital plans even if it fails the test; that is, there would essentially be no consequence to a bank for flunking the test.

“Living wills” are an essential early defense to protect us from the catastrophic failure of a large banks, but after years of effort, regulators still find that many of these banks continue to pose a threat to our financial stability. The CHOICE Act waters down the “living will” process, cutting the number of submissions in half, and requiring regulators to tell the banks how the wills will be graded, so they can game the system and ensure they pass.

Crippling the Financial Stability Oversight Council

The Financial Stability Oversight Council (FSOC) was created to be an early warning system to help detect and prevent future financial, economic and human calamities like those of 2008-2009. Congress created the FSOC with widespread bipartisan support as well as support from the banking industry, in response to the catastrophic failure of unregulated systemic threats like American Insurance Group (AIG).

AIG’s failure happened because no one regulator was responsible for overseeing the systemic risk posed by the firm. That is why, in the immediate aftermath of the crisis, it was widely agreed that fixing this regulatory gap required a single regulator to oversee systemic risk across the financial system, and act decisively to address it. The financial industry, including representatives of the Financial Services Forum, the Investment Company Institute, the American Bankers Association, and the Securities Industry and Financial Markets Association, supported the creation of the FSOC.[2],[3],[4],[5] 

To stop future crises, we need a strong and effective FSOC. But the CHOICE Act would cripple the FSOC’s operations and make its effective oversight of the industry impossible.

For example, the CHOICE Act would retroactively repeal the FSOC’s designations of certain nonbank financial firms as systemically important and prohibit the FSOC from making any such designations in the future. It would strip the FSOC of its ability to prohibit or otherwise limit Wall Street firms from engaging in certain risky activities, and tie up the Council’s budget and operations with Congressional interference. The CHOICE Act’s micromanagement of the FSOC even dictates how the Council should hold its internal votes.

These measures would paralyze and politicize the decision-making process, turn future FSOC votes into a partisan exercise, and lead to unnecessary delays, weaker decisions, and a greater risk of future AIGs.

The FSOC needs flexibility, discretion, and independence to identify new and emerging risks and keep abreast with market developments and financial innovations. The CHOICE Act would add unnecessary layers of bureaucracy for the FSOC and undermine its mission, putting us all at risk.

[2]         Testimony at House Financial services Committee (July 17, 2009).

[3]         Testimony at Senate Banking Committee hearing (July 23, 2009).

[4]         Testimony at House Financial Services Committee (July 17, 2009).

[5]         Testimony at House Financial Services Committee (Mar. 17, 2009).



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