How Trump can grow the economy by $351 billion

Getty Images

Want to add $351 billion to the U.S. economy over the next decade? Do nothing. That is to say, do nothing to the capital requirements at the core of the Dodd-Frank financial regulation law that has somehow earned the enmity of President-elect Donald Trump and Republican congressional leaders.

The same cost-benefit analyses that Republicans demand of other regulations show that these Dodd-Frank rules benefit economic growth more than they slow it, based on data gathered by stodgy, objective, international banking experts. My new report for Third Way finds that increased capital and liquidity requirements elevate the level of U.S. GDP in the long-run by 1.62%.

{mosads}The big benefit comes from Dodd-Frank rules known as risk-weighted capital and liquidity requirements. They may not be household terms, but they should be. That’s because risk weights are the most effective way to reduce the chance of another financial crisis.

The reason so many banks failed or needed rescue during the last crisis was that they did not have enough capital on hand. Capital is simply the amount by which a bank’s assets (what it owns) exceeds its liabilities (what it owes).

Under Dodd-Frank, the new math is that the riskier your bank assets, the more capital you need in case they tank. For example, the asset of cash gets a higher rating than holding a subprime mortgage in a housing development in exurban Las Vegas. And it should, because when the housing crisis dragged down the value of mortgage securities, many banks wound up owing more money to their creditors than they had in total assets. Their capital was wiped out.

What the banks failed to consider was how risky their assets were. Now, with Dodd-Frank risk weights, banks must set aside an extra buffer of capital for any asset that isn’t cash or Treasury bonds.

Seems reasonable, right? Yet the Financial Choice Act, expected to be reintroduced by House Financial Services Committee Chairman Jeb Hensarling, would repeal and replace risk-weighted capital requirements with a much weaker alternative: the leverage ratio. It doesn’t include risk weighting, and even worse, it would allow banks that meet the leverage ratio to get out of all of Dodd-Frank’s other important reforms, like stress tests and living wills.

Why would we want to go back to the old banking system where subprime mortgages were treated just like cash? Well, the free-marketeers behind the Financial Choice Act want you to believe that Dodd-Frank rules like risk weights cost too much. “If only we did a cost-benefit analysis!” they complain.

So we did. Ours is based on two in-depth academic research reports published by the Bank for International Settlements. We use their same methodology, but we fine-tune the data to reflect the structure of the U.S. banking system. There are two reasons for this: The U.S. banking system is less concentrated than that of other countries, and our rules on the biggest banks are tougher because of Dodd-Frank.

First, we look at costs—and yes, there are some. Specifically, lending becomes slightly more expensive when banks are required to maintain higher capital.

But once the new risk weights are in place, the benefits greatly exceed the costs. For every incremental improvement in banks’ levels of risk-weighted capital, the probability that a bank will set off another financial crisis is reduced, as well as the amount of losses that a bank’s failure would cause.

These benefits may seem difficult to estimate because they represent the lack of something really bad happening, but they have real economic value. The longer we can go without a crisis, the more the economy can grow. That’s what creates $351 billion worth of GDP over ten years.

We all benefit from policy that reduces the risk of a future financial crisis, but our memories must be so short that this gets left out of cost-benefit analyses that only account for the impact on corporations. As we learned in 2008, that’s a catastrophic mistake.

The financial crisis destroyed 8.7 million American jobs, wiped out $2.8 trillion in retirement savings, and led to the foreclosure of 15 million homes. If those aren’t significant costs for a policymaker to consider, then what else is?

If Trump is serious about economic growth, he would do well to support the very law that protects the American people from the damage of another financial crisis. And to do that, all he needs to do is nothing.

Emily Liner is an economics policy advisor at Third Way, a centrist think tank in Washington, D.C.

The views expressed by authors are their own and not the views of The Hill.

Tags Donald Trump

More Economy & Budget News

See All
See all Hill.TV See all Video