Now is the time to guard against reckless banking legislation

All of this has happened before, and it will all happen again. The cycle of financial deregulation followed by financial calamities has a sickening familiarity to it. Our only hope for breaking out of this wasteful and destructive cycle is to learn enough from one of the crises to install reforms durable enough to have a chance to survive the money-induced amnesia that will inevitably follow.

The failures of Silvergate, Silicon Valley and Signature Banks provide us an opportunity to learn, and to act.

In the early 1980s, Ronald Reagan’s election accelerated a wave of deregulatory fervor in both Congress and state capitals. Savings and loan executives wanted to take on riskier, higher-risk investments, and nobody was telling them “no.” Even as the savings and loan crisis was gaining momentum, S&L lobbying killed a Reagan administration bill to contain the damage. The result was $160 billion in losses.

President Clinton and congressional Republicans worked together on “financial services modernization.” Loosened restraints led to the wild irresponsibility of subprime mortgage lending, the creation of opaque securities whose value was impossible to ascertain, and a plethora of other abuses that caused the financial system to seize up after Lehman Brothers collapsed. The subprime crisis brought us the Dodd-Frank Act seeking to prevent a repeat of those abuses.

Memories, alas, proved short. When President Trump proposed relaxing Dodd-Frank standards less than a decade later, almost all congressional Republicans and enough Democrats were happy to oblige. One of the leading advocates — and beneficiaries — of the loosened standards was Silicon Valley Bank. SVB’s leader reportedly assured members of Congress that his bank had other robust risk management measures. Instead, it turns out that it had no risk management chief at all for most of last year as it was making blunder after blunder, ultimately sealing its fate.

Each of these rounds of ruinous financial deregulation looked like essentially free votes to members of Congress. Lobbyists showered them with meaningless promises of adequate safeguards — and huge volumes of cash.

Neither political party can be trusted to resist bank lobbyists. Deregulation is central to Republicans’ agenda, but “New Democrats” like Bill Clinton periodically try to steal their brand. Indeed, four of the Keating Five senators accused of abetting the irresponsibility causing the S&L Crisis were Democrats. Signature Bank had close ties with the Trump family — and paid former Democrat Rep. Barney Frank $1 million to lobby through President Trump’s legislation exempting banks like Signature from the Dodd-Frank rules Frank helped write.

Predictable voices condemn “bail-outs” and demand “free market” solutions. Bank runs are, in fact, a free market phenomenon. They are also breathtakingly inefficient: Depositors have little capacity to determine the soundness of banks and quite rationally race for the exits at the first sign of trouble. This results in huge losses that ripple through the economy, wasting productive potential and making us all poorer. Regulators can determine banks’ soundness much more accurately and efficiently.

Bank executives, shareholders, and bondholders — who could and should have assessed a bank’s soundness — should lose their jobs and investments, a step the Bush and Obama administrations resisted taking. But failing to protect all deposits ensures more bank runs by rewarding those who pull their money out and punishing those who resist panic. No useful purpose is served by making depositors divide their money into multiple accounts under the current $250,000 FDIC insurance limit. That limit is barely two-thirds of the $100,000 limit set in 1980 adjusted for inflation. And over those decades, market concentration and growing inequality have led to many more large accounts. Silicon Valley Bank’s failure shows that the flight of accounts over the current limit is more than enough to crash a large bank, with far-reaching consequences.

Only a structural change to the way Congress acts on financial regulation will prevent future losses. Our budget process rules provide a good guide.

For almost half a century, the Congressional Budget Act has required the Congressional Budget Office to estimate the likely effects of major fiscal legislation. That has not avoided deficit-increasing legislation with strong support, such as the Republican upper-income tax cuts of 2017, the bipartisan coronavirus relief legislation of 2020, or the Democrats’ American Rescue Plan Act of early 2021. Congressional budget rules have, however, derailed some popular legislation completely and forced other bills’ sponsors to find offsets for new spending or tax cuts. More impressively, it caused major legislation, such as the Affordable Care Act (Obamacare) and last year’s Inflation Reduction Act to go beyond paying for their costs and include major deficit reduction.

Financial regulatory legislation has more impact on this country’s finances than the vast majority of explicitly fiscal legislation. Lax standards can lead to banks taking on excessive risks that lead to large losses and potential collapses. The cost of these failures can require large public expenditures for deposit insurance as well as subsidies to stabilize other banks. And, as we saw in both the S&L crisis and the subprime crisis, important financial institutions’ failures can spark national or even international recessions. Even a moderate recession can worsen our fiscal condition more than fiscally irresponsible legislation.

We should require the Congressional Budget Office to estimate the likely effects of any changes to our financial regulatory system. Even if relaxed standards would only increase the chances of a crisis by ten percentage points, creating a ten percent chance of a $200 billion calamity is still a major fiscal decision and should be treated as such.

Some members of Congress may actually believe lobbyists’ claims that deregulation will be harmless, just as some believe unfounded claims that this or that tax cut or spending program will “pay for itself.” A CBO estimate would provide an impartial second opinion on bank lobbyists’ fanciful assertions. Other members of Congress may not care about increasing risks — but might think twice before voting for proposals that could get them branded as “budget-busters.”

This would not be terribly different from kinds of estimates CBO and the Joint Committee on Taxation already provide. When Congress raises tobacco taxes, revenue projections are discounted to reflect people prompted to quit smoking. When Congress changes capital gains tax rates, revenue estimates assume that investors will speed up or put off asset sales.

Even if assessments on banks would fully pay for repaying depositors, those are still taxes whose impact on the economy should be estimated impartially. Increases and decreases in regular unemployment insurance benefits are quickly offset by changes in employers’ taxes, but CBO still estimates legislation’s effects on those benefits to help Congress and voters assess those trade-offs.

Cost estimates will not guarantee the defeat of bank lobbyists’ greedy proposals. Nothing will. But in a situation where we can rely on neither party to blow the whistle, CBO could be an “excellent skunk at the congressional picnic.”

David A. Super is the Carmack Waterhouse Professor of Law and Economics at Georgetown University Law Center. He also served for several years as the general counsel for the Center on Budget and Policy Priorities. Follow him on Twitter @DavidASuper1