AEI scholar Alex Pollock's testified on The Dodd-Frank Act's Effects on Financial Services Competition before the U.S. House Subcommittee on Intellectual Property, Competition, and the Internet.

Pollock makes the following points:

• There are recurring cycles in lending: (1) over-optimistic credit expansion ending in a bust, followed by (2) legislation and expanded regulation in order to prevent the next crisis, though (3) the next crisis always comes anyway.
• Just as the FDIC Improvement Act of 1991 and the 2002 Sarbanes-Oxley Act were not able to thwart future crises, the increased bureaucracy and regulation mandated by the Dodd-Frank Act will not prevent a future crisis.
• Dodd-Frank will greatly increase the regulatory burden on financial businesses, including community banks.

The bill negatively effects competition in financial markets in three major ways:

• Small institutions are affected more heavily by the expensive and complex, regulatory requirements of Dodd-Frank. The burden will be disproportionately heavier for small firms while larger companies will be advantaged.
• New mortgage regulations will reduce the role of local community banks in the residential mortgage market: Dodd-Frank does not allow local banks the freedom to make the choice to assume credit risk for loans about their customers in their town.
  
  
  
  • The law’s "QRM" (Qualified Residential Mortgage) rule will be used to determine whether mortgage lenders are required to retain credit risk in mortgages sold for securitization. The rule places credit risk on local banks through a mandatory and formulaic requirement, rather than in a voluntary market environment. A better approach would be to facilitate and encourage mortgage credit risk retention by lenders, but not mandate it.
  • Local banks will be exempt from credit responsibility if they sell their loans to Fannie and Freddie. This rule increases the Fannie and Freddie problem as it gives banks an opportunity to concentrate mortgage risk in the duopoly.
    
    
• The designation of "Systemically Important Financial Institutions" (SIFI) will eliminate competition and tend to consolidate financial markets: The designation of very large financial firms as SIFI by Dodd-Frank will burden these firms with increased regulations and oversight.  Because SIFIs will be perceived as safer, they will probably have an advantage as to the amount and cost of funds and deposits available to them. They will be the preferred entities in financial transactions as opposed to their smaller competitors.

Alex Pollock is a resident fellow at the American Enterprise Institute (AEI). He was president and CEO of the Federal Home Loan Bank of Chicago from 1991 to 2004. He can be reached at 202.862.7190.

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