In the aftermath of the 2007-2009 financial crisis, the Government Accountability Office (the “GAO”) issued a report (the “GAO Report”) examining the losses associated with the recent financial crisis, the benefits of the Dodd-Frank Act for the U.S. financial system, and the potential costs associated with the Dodd-Frank Act.
Losses Associated with the Financial Crisis. The GAO Report states that the total losses associated with the 2007-2009 financial crisis could exceed $10 trillion. These losses stem from a steep decline in U.S. output and a severe economic downturn. The Congressional Budget Office estimates GDP may recover to its potential level by 2018; however, the GAO Report indicated that some research suggests output losses could persist well beyond 2018. In addition, the GAO Report points to increases in unemployment and declines in household wealth as significant losses associated with the crisis. The GAO Report states that persistent unemployment may result in a range of negative consequences, including skill erosion, lower future earnings, health problems and fewer educational and occupational opportunities for those affected. Declines in home prices and the value of financial assets has also led to a decrease in overall household wealth. Finally, the GAO Report notes the greater fiscal challenges faced by the government as a result of the financial crisis. Specifically, declines in output, income and employment have resulted in less tax revenue for federal, state and local governments, while the demand for social welfare services has simultaneously increased.
Costs Associated with the Dodd-Frank Act. After summarizing the benefits of the Dodd-Frank Act, the GAO Report discusses the potential costs associated with the Dodd-Frank Act. While the Dodd-Frank Act may improve the financial system’s resilience, it will also impose a number of costs on the government and the financial industry as a whole. First, in order to implement and comply with the Dodd-Frank Act, federal agencies must devote resources to fulfill their rulemaking and regulatory responsibilities. The GAO Report also notes that additional regulations imposed by the Dodd-Frank Act on financial institutions will increase regulatory compliance costs. Examples of compliance costs identified in the GAO Report include the costs for regulated firms to hire and train staff and management, devote time to compliance activities, and hire outside counsel and experts. The GAO Report notes that provisions within the Dodd-Frank Act specifically target large financial firms and that their compliance costs are expected to increase significantly more than those of other financial firms. For example, the GAO Report notes that several provisions within the Dodd-Frank Act apply only to systematically important financial institutions, which include bank holding companies with total consolidated assets in excess of $50 billion. Notwithstanding the foregoing, the GAO Report also notes that a number of the provisions within the Dodd-Frank Act are expected to impose costs on non-bank financial institutions as well. The GAO Report states that the full impact of the Dodd-Frank Act on financial firms’ business remains uncertain and financial institutions are finding it difficult to measure the regulatory compliance costs because of the piecemeal way the Dodd-Frank Act is being implemented. As a result, no comprehensive data is readily available regarding the costs of regulatory compliance for financial institutions.
The GAO Report also states that certain provisions may reduce revenue of financial institutions as a result of the restrictions imposed by the Dodd-Frank Act. Examples of such provisions provided in the GAO Report include (i) the Volcker Rule, which may eliminate sources of trading and fee income for some banks by prohibiting banks from engaging in proprietary trading and restricting their sponsorship or investments in funds; (ii) swap reforms which may result in a reduction in the volume of high-profit margin swaps; (iii) the single counterparty credit limits which may decrease the derivative activity and securities lending of some banks; and (iv) the cap placed on debit card interchange fees charged by debit card issuers with at least $10 billion in assets. The GAO Report explains that quantifying the potential costs associated with the Dodd-Frank Act is difficult and the magnitude of such costs will depend, in part, on how the reforms are implemented.
In addition to the increased costs imposed on regulatory agencies and financial institutions, the GAO Report points to concern over potential unintended consequences that may result from the implementation of the Dodd-Frank Act reform. Specifically, academics and industry representatives believe that by imposing higher costs on financial institutions, the Dodd-Frank Act may indirectly impose higher costs on businesses and households, reducing their investment and consumption with a consequent effect on economic output. Similarly, the Dodd-Frank Act could make the financial system more vulnerable to a crisis. For example, the GAO Report notes that “some experts suggest that higher capital, liquidity and collateral requirements will cause regulated institutions to increase significantly their holdings of relatively safe and liquid securities, such as U.S. Treasuries.” As noted in the GAO Report, such a scenario could inflate the value of securities, which could result in large losses from a subsequent correction in the valuation of the securities. In addition, the GAO Report states that the Dodd-Frank Act may lead to an inadvertent reduction in the competitiveness of U.S. financial institutions. Experts have expressed concern that the increased regulation of the U.S. financial system may cause financial activities in the United States to move to foreign jurisdictions with less stringent regulations. The GAO Report indicated that, while some quantifiable data exists regarding the potential costs associated with the Dodd-Frank Act, other costs and the impact on the economy as a whole, cannot be easily quantified (and the GAO does not offer its own quantification of these costs).