How Dodd-Frank explains our weak recovery

Yesterday, John noted how weak the Obama economic “recovery” has been. As he put it, “the Obama economy has been, in a word, lousy, and its lousiness is most evident in the fact that full-time jobs have been so scarce that tens of millions have quit looking. . . .”

Why, though, hasn’t the economy taken off under Obama, as it did in the past following recessions? Democrats attribute the problem to the fact that the 2008 recession was the product of a financial recession.

But Peter Wallison of AEI points out that recoveries after financial crises typically are stronger than other recoveries. This is the finding of a study by Michael Bordo and Joseph Haubrich of 27 recession-recovery cycles since 1882. Bordo and Haubrich found that “the stylized fact that deep contractions breed strong recoveries is particularly true when there is a financial crisis.”

Clearly, Obama and his apologists cannot blame the absence of a robust recovery on the financial crisis that produced the recession.

What, then, is to blame? John pointed to “the Democrats’ liberal policies, most notably the hyper-regulation that seeks to concentrate all power in the government.” Wallison agrees.

He ties the weak recovery to a particular instance of hyper-regulation — that brought about by Dodd-Frank. Wallison notes that studies of Dodd-Frank’s effect have shown that the regulatory burdens imposed by that law have been particularly harsh for community banks:

A 2012 Government Accountability Office study showed that 7 of the 16 titles in Dodd-Frank had potential adverse effects for these banks, and studies by scholars at George Mason University and Harvard’s Kennedy School have found significant compliance cost increases attributable to Dodd-Frank. “Since the second quarter of 2010,” said the Harvard study, “around the time of [Dodd-Frank’s] passage, we found community banks’ share of [US banking] assets has shrunk drastically—over 12 percent.”

Harming community banks harms small businesses. Unlike large companies, they typically don’t have access to financing in the capital markets that have been largely unaffected by Dodd-Frank. They must rely primarily on banks to meet their credit needs.

This, says Wallison, is where the costs loaded on small banks begin to affect U.S. economic growth:

Regulatory costs affect small banks more than large banks because the costs are largely fixed and large banks by definition have a bigger asset base over which to spread these costs.

When a small bank is required to hire a compliance officer, that is an employee who is not making loans or producing revenue. When the Consumer Financial Protection Bureau—set up by Dodd-Frank and the bane of small banks—sends out a 1,099-page regulation on mortgage lending, that means a community bank must engage a lawyer to interpret the new regulation, a compliance officer to apply the regulation in individual cases, and a tech firm to retool its mortgage underwriting system.

All costs, no revenue, and fewer funds to lend.

When a bank examiner criticizes a loan because the bank does not have audited financial statements for a customer who has never missed a payment in 20 years, that forces a bank to revise its business model and change its customer relationships. Again, costs for the bank and less financing for the small business.

Wallison tests his thesis regarding the impact of Dodd-Frank by comparing the growth rates of small and large businesses since 2010. He points to a Goldman Sachs report published in April 2015 and titled “The Two-Speed Economy.”

[T]he authors found that firms with more than 500 employees grew faster after 2010—the year of Dodd-Frank’s enactment—than the best historical performance over the last four recoveries. These firms largely had access to the capital markets for credit.

However, jobs at firms with fewer than 500 employees declined over this period, although this group had grown faster than the large-firm group in the last four recoveries.

This is what one would expect if, in fact, Dodd-Frank is hurting small businesses.

Between 2002 and 2010, 64 percent of net new jobs in the U.S. economy came from employment by small business. Since the enactment of Dodd-Frank, this source of growth has disappeared. As Wallison concludes, “while larger firms have access to credit in the capital markets, millions of small firms, limited to borrowing from beleaguered community banks, are not getting the credit they need to grow and create jobs.”

It seems, then, that Dodd-Frank bears much blame for the historically poor Obama recovery.