Eleven years ago, the U.S. financial-service industry was teetering on the precipice of a real-estate bubble-bursting collapse that threatened to drag the U.S. and global economies into a second Great Depression.

As those economies try to ride out the current COVID-19 pandemic, the U.S. financial-services industry is being touted as a source of strength and stability.

A pivotal difference: regulations at the heart of the controversial Dodd-Frank Wall Street Reform and Consumer Protection Act that was signed into law by President Barack Obama in July 2010.

The law initially required the nation’s largest banks and financial-services corporations — those with at least $50 billion in total assets — to maintain a high enough level of capital to be able to weather a severe economic downturn.

Those financial requirements are being tested, if not stretched to the point of breaking, for the first time as local and state economies are shut down by stay-at-home government orders amid the coronavirus pandemic.

Other analysts worry that since Dodd-Frank was meant to avoid another financial-services crisis, it is not designed to thwart a public-health crisis over a painful extended period.

Dodd-Frank restrictions were eased in May 2018 to apply only to financial institutions with more than $250 billion in assets —just 14 institutions in the country.

Those institutions serving the Triad include Bank of America Corp., Wells Fargo & Co., Truist Financial Corp. (still operating at BB&T and SunTrust Banks at the retail level) and PNC Financial Services Corp.

“There has been a persistent argument in recent years that banks don’t need as many rules and protections because the post-crisis reforms have enabled them to weather any storm,” Graham Steele, staff director for the corporations and society initiative at Stanford Graduate School of Business, said in an April 2 opinion piece in American Banker.

“Now, that an economic tsunami has arrived, how the system responds will raise important questions about a path forward.”

Check on financial services

The law was designed as a check against financial-services companies, particularly banks, overextending themselves with loans and exposure to exotic securities trading that contributed significantly to the financial crisis of 2008-11.

Wachovia Corp., Washington Mutual and Lehman Brothers were the most prominent financial collapses of the Great Recession.

“Banks of all sizes are much better capitalized now than prior to the Great Recession, and in a way that we couldn’t fully appreciate just two months ago,” said Greg McBride, an analyst with Bankrate.com.

The carrot and stick of Dodd-Frank regulations:

The Federal Reserve must sign off on the financial institutions’ stress-test projections before their board of directors could approve lucrative dividend increases, share repurchases and, in some instances, major acquisitions.

However, banks not able to meet their required capital levels were instructed to compose a “living will” that would represent their plan for filing for bankruptcy and selling off key assets of the business.

The capital levels of financial institutions subject to Dodd-Frank have been evaluated twice a year since 2013.

During the years that Dodd-Frank stress tests have been mandated, the main economic measuring sticks have been the U.S. unemployment rate, decline in the Dow Jones Industrial Average or S&P 500, decline in housing prices, and decline in real gross domestic product.

The composite worst-case scenarios over the past seven years have been: a 12.1% U.S. unemployment rate; 65% plunge in the Dow Jones Industrial Average; 35% drop in housing prices; 40% decline in commercial real-estate prices; and an 8.9% fall in real gross domestic product.

For example, Wells Fargo & Co. projected in June that it would experience an overall $17 billion revenue loss if the U.S. economy were to go through a severe downturn during a 2½-year period ending March 31, 2021.

In October 2018, the last time BB&T was required to conduct a stress test, it projected an overall $2.4 billion revenue loss if the U.S. economy were to go through a severe downturn during a 2½-year period ending Sept. 30, 2020.

Measuring sticks

It likely will take weeks, if not months, to determine whether the current economic crisis will cause any of those scenarios to be reached or exceeded.

However, most economists are projecting an April unemployment rate of between 8.5% to 12.5%, and likely higher in May and June.

By comparison, the N.C. rate reached a 33-year peak of 10.9% in 2010 as the state and national economies began their slow recoveries from the Great Recession. The Triad peak was 11.5% in February 2009.

The all-time monthly record for the state jobless rate was 27% in 1933 when the state population was at 3.27 million. The rate was at or above 14% for most of 1931 to 1940.

By comparison, a 12% jobless rate today would represent about 613,000 unemployed North Carolina out of 5.11 million in the labor force.

Steele said that “like the mortgage crisis, the coronavirus pandemic comes at a time when corporate profits were high, unemployment was low and growth was steady.”

“But unlike the last crisis, the triggering event originated outside the financial system.

Steele said that “the actual conditions created by the COVID-19 pandemic have quickly eclipsed some of the worst-case hypotheticals of supervisory stress tests, with warnings of potentially even worse things to come.”

‘Pain will be felt by all’

McBride said that “even the so-called severe scenarios in the stress tests don’t come close to touching what we’re going to experience economically.”

“Banks may be among the better positioned of all industries due to their enhanced capital positions and sound lending standards, but the pain will be felt by all.”

McBride predicted that compared to the Great Recession, “we’re going to see much worse than that this time around” in terms of economic activity and unemployment.

“At the very least, this is going to be a bad recession. Hopefully, it’s not a depression.”

Peter Gwaltney, president of N.C. Bankers Association, said “it’s entirely possible that Dodd-Frank played a key role in banks being able to provide the lines of credit they are offering now.”

“They certainly entered the public-health crisis much stronger, well capitalized and basically in every metrics for the industry.”

However, Gwaltney cautioned that Dodd-Frank “was just a component” of the industry’s overall strength.

He credited the sometimes painfully slow economic recovery that began to be felt in earnest in 2012 with allowing the financial institutions targeted by Dodd-Frank to add capital by acquisitions and selling stock during an overall vibrant economy.

“Dodd-Frank’s influence on individual banks’ financial strength differed to some degree because it affected each bank differently,” Gwaltney said.

Credit or blame?

How much credit to give Dodd-Frank depends on where you fall on the socioeconomic and political ideological spectrums.

There are industry experts and advocates who claim Dodd-Frank is why the then-50, now-14 largest financial institutions are in the position to make loans.

Others say that while Dodd-Frank kept capital levels at high levels, it also hamstrung those banks’ ability to fully fulfill its loan-making capabilities.

That’s in spite of record multi-billion-dollar levels of quarterly dividend payments and repurchased shares that passing Dodd-Frank stress tests enabled financial institutions to pay out.

In March 2015, 10 super-regional banks, including BB&T and SunTrust, said they “welcome appropriate government regulation, based on risk and business model, to assure our safety and soundness.”

“But regulation should be tailored to risk, not based on arbitrary thresholds (of $50 billion) that don’t differentiate between business models. Despite their larger size, regional banks have a business model that closely resembles that of community banks.”

Such grumblings found sympathetic ears with the administration of President Donald Trump and a Republican-controlled Congress in 2018.

Congress passed legislation that raised the total asset level — from $50 billion to $250 billion — for a bank to be subject to Dodd-Frank restrictions.

Loan demand or not

The theory among some banking analysts is that reducing or eliminating Dodd-Frank regulatory costs would free banks no longer subject to the law’s regulations to provide more funding for loans, particularly to companies that could benefit from increased business spending on equipment.

However, those same analysts caution that even if there is more funding available, there still has to be enough confidence among companies, suppliers and consumers about the U.S. economy to extend themselves by taking on new loans.

Gwaltney said the U.S. economy was slowing down before the first major blow was felt from the pandemic.

“It might have been psychological that many businesses were not borrowing or expanding with all the positives in the economy before the pandemic arrived,” Gwaltney said.

“It might have been psychological why it seemed like we were putting our left foot on the brakes of the economy.

“There was a growing sense we were closer to the next recession than we were away from the last recession.”

Gwaltney credited the lessons the financial-services industry learned from the Great Recession and Dodd-Frank for an expectation of fewer loans defaults — at least for now.

“Companies have been by-and-large sitting on cash, being cautious rather than exposing themselves with unnecessary loans,” Gwaltney said.

“People are asking me if credit will become too easy and too loose at this time.

“I believe that even as loans are being made to keep small businesses alive that credit terms will remain tight and where they prudently need to be.”

Too early for ‘I told you so’?

Bart Smith, a partner with Performance Trust Capital Partners in Charlotte, said that “an argument could be made that the pendulum has swung too far and that higher bank capital levels are thwarting needed stimulus.”

“The regulators have certainly acknowledged this through the recent loosening of certain capital measures in an effort to encourage lending and increase banking activity.”

Smith said he thinks “it is too early to opine on the long-term financial impact of this current crisis, but I don’t think this will deteriorate into a catastrophic event for the banking industry.”

So, perhaps it’s a bit too early to say ‘I told you so.’

“The struggle to sustain the right level of capital will always be a challenge for banks and their regulators, but cooperative actions to make sure the right balance is maintained will be good for everyone,” Smith said.




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