By Josh Bivens and Heidi Shierholz, Economy Policy Institute
Today the U.S. House of Representatives begins consideration of the Financial CHOICE Act of 2017, a sweeping bill that would make a number of extensive changes to the institutions that oversee the American monetary and financial system.
The CHOICE Act is frequently (and accurately) described as an effort to undo much of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which is the critical banking regulation passed under President Obama after the financial crisis of 2008/2009 to help avert future crises. The provisions in the CHOICE Act that repeal major parts of Dodd-Frank have rightly received a great deal of attention. But, there is more to the CHOICE Act than rolling back Dodd-Frank. Below we highlight two lesser-known but highly concerning components of the bill.
The CHOICE Act would make major and undesirable changes to the governance and conduct of the Federal Reserve.
The status quo of the Federal Reserve should not persist. Governance should become more transparent and representative and policy should weigh the economic interests of low and middle-wage workers more highly. But the reforms proposed in the Financial CHOICE Act go in precisely the wrong direction regarding both governance and policy conduct of the Fed.
In regard to governance, the Financial CHOICE Act proposes expanding the influence of regional Federal Reserve Bank presidents on the Federal Open Market Committee (FOMC), at the expense of the Federal Reserve’s Board of Governors (BOG). Regional presidents are chosen through largely opaque processes led by regional Federal Reserve Bank boards of directors. These regional boards are dominated by financial and corporate interests. Fed Governors, conversely, are nominated by the President and must be confirmed by the Senate. This insures at least some modicum of democratic accountability. Voting rights on the FOMC are supposed to be split 7-5 in favor of the BOG (currently there are two vacancies on the BOG, so the regional banks already have parity).
The FOMC was created explicitly with the intention of ensuring that democratically accountable Governors, and not regional Presidents chosen by financial and corporate interests, would constitute a majority of the voting members.
By expanding the number of Reserve Bank presidents sitting on the FOMC from five to six, the Financial CHOICE Act would tilt the FOMC balance further away from this democratic accountability and towards greater financial sector influence on Fed policymaking.
In regard to policy, the Financial CHOICE Act would result in worse monetary policy not just through its degradation of Federal Reserve governance, but also through the specific reforms it calls for in how policy is set.
Concretely, the Financial CHOICE Act mandates a specific “Directive Policy Rule “ (DPR) that the Fed must follow when setting interest rates. If the Fed deviates from such a rule, it would face an audit by the GAO. The DPR to be followed is a rigid version of the “Taylor Rule”, named for Stanford economist John Taylor, a rule clearly meant to be descriptive, not prescriptive, of Fed actions.
The first thing to note about what a bad idea the DPR would be is that even Taylor himself has opposed using it so mechanically: “…in my view, a policy rule need not be a mechanical formula…A policy rule can be implemented and operated more informally by policymakers who recognize the general instrument responses that underlie the policy rule, but who also recognize that operating the rule requires judgment and cannot be done by computer.”
Taylor’s caution is well-founded. To take just one example, if a strict Taylor Rule like the one mandated in the Financial CHOICE Act was followed during a period of time when the “neutral” real interest rate was secularly changing, it would lead to very large policy errors. The neutral real interest rate is the federal funds rate consistent with the economy growing at trend with stable inflation. But, much research indicates exactly that the neutral real interest rate in the United States (and likely globally as well) has indeed been changing significantly in recent years (see Laubach and Williams (2015), for example). Put simply, if the Financial CHOICE Act’s Taylor Rule mandate had been in effect over the past decade and had been followed, monetary policy would have made very large policy errors that would have led to millions of fewer Americans working today.
The CHOICE Act repeals the “Conflict of Interest” (or “Fiduciary”) Rule
The CHOICE Act has a provision (Sec. 841) to repeal the Department of Labor fiduciary rule. The fiduciary rule (also sometimes referred to as the Conflict of Interest Rule) is the rule that requires that financial advisers act in the best interest of their clients —like doctors and lawyers are already required to do. It prohibits financial advisers from doing things like steering clients into investments that provide the adviser a higher commission but provide the client a lower rate of return. This rule is sorely needed—conservative estimates put the cost to retirement savers of “conflicted” advice by financial advisers at $17 billion a year.
By tucking the repeal of the fiduciary rule into the CHOICE Act, Republicans in the House have chosen to side with unscrupulous actors in the financial industry who profit handsomely from the loopholes that have allowed them to fleece retirement savers. It’s worth noting that Republicans in Congress are operating in parallel with the Trump administration, which has also made it clear from the beginning that weakening or rescinding the rule is a core priority. In the second week of his presidency, President Trump issued a Presidential Memorandum directing the Department of Labor to prepare an analysis concerning the likely impact of the rule – despite the fact that the department had already completed a roughly six-year, exhaustive vetting process. The directive forced a delay of the rule, and though on Friday it will be partially implemented, the department is not going to enforce it and Secretary Acosta has made it clear that he intends to “revise” (read: weaken) the rule.
These provisions of the CHOICE Act would have devastating effects on the ability of regulators to protect investors from exploitation. They would also further solidify both the policy preferences and the policy influence of the financial sector over monetary policymaking. As a whole, the CHOICE Act would expose consumers and investors to heightened risk of abuse in their normal dealings with the financial sector, and would expose the broader economy to increased risk of another financial crisis.