Presidential Pendulums in Finance

While much attention has been paid to President Trump’s deregulatory efforts and intentions, presidential involvement in the work of the administrative agencies is not new.  Past presidents including Ronald Reagan, Bill Clinton, and Barack Obama have acted up to – and at – the limits of presidential power in efforts to ratchet-up, or ratchet-down, regulation.[1]

My recently published article, Presidential Pendulums in Finance, examines the past decade of presidential involvement in financial regulation in particular.  As the paper explains, presidential involvement in financial regulation over the past 10 years stands to quicken the rate at which regulatory cycles repeat, with potentially unintended macroeconomic consequences.

Historically, as scholars like John Coffee have pointed out, financial regulation ebbs and flows.[2]  Financial crises often lead to financial legislation, as they command public – and hence Congress’ – attention.  After laws are made, however, the regulatory frameworks themselves can adjust only so quickly.  There is some backend work that must be done in the financial regulatory agencies to implement the intricacies of the law’s purpose and its goals.  Pursuant to that process, governed by the Administrative Procedure Act (“APA”), the financial regulatory agencies – acting on Congress’ delegated authority – engage in a formal notice and comment process that invites public participation in the shaping of the rule.  This process takes time, involves deliberation, and does not move terribly quickly.

Financial regulatory frameworks tend to ebb after a period of time, when experts and industry voices discover – and explain – how any given regulatory framework may have been overbroad, had undue costs, or had unforeseen and socially costly consequences.  In turn, after due consideration, the financial regulatory agencies can implement some deregulation or tailoring to address the relevant concerns and enhance the efficiency and efficacy of a regulatory framework.  Again, the process proceeds in a transparent and deliberative way under the aegis of the APA.

However, since 2010, we’ve seen both the Obama and Trump administrations creatively use various levers to push and pull on the financial regulatory frameworks in ways that short-circuit the (relatively slower) APA process.  President Obama, for example, made ample use of guidance in order to increase the stringency or substance of regulatory frameworks without in fact implementing a new rule.  One well-known example of this is the issuance of inter-agency leveraged lending guidance in 2013 which suggested that any loans made at over six-times debt to EBITDA would be subject to enhanced regulatory scrutiny.[3]

President Trump has also used a variety of levers to dial back financial regulation.  As one example, he attempted to insert the office of the presidency into the notice and comment rulemaking process in ways not typical for the independent financial regulatory agencies. Specifically, the White House suggested that all financial agency rules – including those of the independent financial regulators –  should pass through White House review for a cost-benefit assessment.[4]  As another example, the Trump Administration also selected agency heads of financial regulatory agencies (like the CFPB) who would go light on the enforcement gas.  The administration also pressed for the delay of certain high-impact rules (like the Department of Labor’s controversial fiduciary rule); and, through the Treasury secretary, has (presumably) had some influence over the FSOC’s decision to move away from the nonbank SIFI designation power and toward a less stifling activities-based review.

My paper is not critical of any of these deregulatory outcomes in particular.  Indeed, in other work, I’ve also critiqued the FSOC designation power as overly costly and problematic in its binary design.[5]  The descriptive point is not specific to the substance of any given piece of regulation or deregulation; rather, the point is that, if presidents make full use of their power to alter regulatory frameworks, the effects of those assertions of regulatory power can become economically costly.

Regulation or deregulation through pronouncements rather than law creates market uncertainty and anxiety by raising questions about its enforceability, interpretation, and staying power.  This is difficult for financial services institutions to plan for and understand, adding unnecessary costs to economic activity.  To the extent uncertainty has a chilling effect on certain markets activities, this can hamper credit intermediation and capital markets activities, both of which are necessary for economic growth and resilience. In short, the need for financial institutions to make frequent (and difficult to predict) adjustments or re-calibrations to regulatory swings creates friction in the economy, which creates costs.

These friction costs will be borne partially by the financial sector, but many will be passed on to the real economy in the form of higher costs of capital and a possible rollback of progress toward increasing access to financial markets and advice to retail investors.  Financial cycles are often painful for the real economy, as the down phase and recovery periods of those cycles tend to usher in unemployment and a decrease in the supply of credit.  Hastening the frequency of short-term credit cycles would thus be a social cost that could accompany a lasting practice of presidential involvement in financial regulation.

While the paper is committed to making a macroeconomic point about a presidential practice, there are a few normative takeaways to consider. The first is that Congress  delegates considerable lawmaking power to the financial regulatory agencies (at least in the Dodd-Frank Act and likely going forward), in large part due to the tremendous complexity of the financial markets. These broad delegations create expanded opportunity for presidential interference and, in turn, the quickening of regulatory and financial cycles.

Second, the president, as chief executive, does legitimately require some constitutionally appropriate control over the financial regulatory agencies.  But the mode of exercising that control matters for the rule-of-law – to the extent a president plays a quasi-legislative role in shaping or unshaping rules that Congress asked agencies to make, that exercise of authority should be subject to some oversight and checks that accompany lawmaking in the ordinary course.

Finally, all presidential administrations would be wise to remember that what’s good for the goose is good for the gander.  To the extent any one administration views these informal levers as politically expedient, the changes made or unmade in such fashion can just as readily by unwound by future administrations – with little long-term gain for the economy or the stability of the financial system.

ENDNOTES

[1] Indeed, in her seminal article, Presidential Administration, then-professor now Justice Elena Kagan made this very point – that presidents can use the administrative state to advance pro-regulatory, or deregulatory, policy agendas.

[2] https://scholarship.law.columbia.edu/faculty_scholarship/517/

[3] https://www.federalreserve.gov/supervisionreg/srletters/sr1303a1.pdf

[4] https://www.whitehouse.gov/wp-content/uploads/2019/04/M-19-14.pdf

[5] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2740424

This post comes to us from Professor Christina Parajon Skinner, an assistant professor at the University of Pennsylvania – The Wharton School.  It is based on her recent article, “Presidential Pendulums in Finance,” available here.

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