Parsing the Political Debate on Dodd-Frank

By Rory Eakin

NEW YORK ( TheStreet) -- Dodd-Frank has been touted as the most sweeping financial regulatory reform since the Great Depression. But its impact on small business lending should be negligible.

The Dodd-Frank Wall Street Reform and Consumer Protection Act began as an 848-page document, and the rules and regulations stemming from the initial framework now fill nearly 9,000 pages.

Therefore, it shouldn't be surprising that Dodd-Frank has generated a firestorm of controversy (with plenty of fodder for politicians in both parties) and provided lively discussion during the recent presidential debates. Most relevant to our business at CircleUp , much of the controversy has centered on Dodd-Frank's impact on small banks and the small businesses to which they lend.

The criticism is typically two-fold: Dodd-Frank (1) provides an implicit taxpayer-funded subsidy to large banks by endorsing "too big to fail" (TBTF) institutions and (2) overburdens small community banks with costly regulations.

If small businesses were to experience tighter access to credit as a result of this legislation, this would be a boon for crowdfunding platforms such as CircleUp. Facing higher interest rates from their customary lenders, small businesses might turn to crowdfunding investors rather than to community banks for growth capital.

The reality, however, is that Dodd-Frank's impact on small banks and hence small businesses should be negligible. Here's why:


The lynchpin in the debate over Dodd-Frank's apparent endorsement of TBTF is the infrequently-discussed Orderly Liquidation Authority, or OLA. Dodd-Frank gives the federal government so-called "resolution authority," which empowers the government to unwind failing financial institutions -- including those that have been labeled "systemically important financial institutions" (SIFIs) -- without resorting to ad-hoc taxpayer bailouts.

Let's just hope that the world's brightest financiers, lawyers and politicians can give the OLA some teeth by establishing a systematic way to unwind an institution the size of, say, Citigroup ( C), which has total assets of nearly $2,000,000,000,000 (yes, 12 zeroes). Higher capital standards, more aggressive regulatory oversight and a credible way to be liquidated are by no means a favor to Wall Street banks.

Admittedly, if liquidation remains an empty threat, then SIFI designation ensures that large Wall Street banks are indeed TBTF -- something with which even former Federal Reserve Chairman Alan Greenspan is uncomfortable.

2. High-Cost Regulation

The criticism that Dodd-Frank increases costs for small banks by forcing them to meet cumbersome new regulatory standards is dubious. In reality, much of the new regulation imposed by Dodd-Frank is specifically targeted at bank holding companies with more than $50 billion in assets.

For community banks, it is business as usual. Federal Reserve Chairman Ben Bernanke has admitted as much. "I think it is important to emphasize that the vast majority of the provisions of the Dodd-Frank Act do not apply to community banks at all," Bernanke told reporters in September. Moreover, this message was reiterated in a recent Federal Reserve publication.

The long-term impact of Dodd-Frank on the financial system remains unclear, but its intention is to scrutinize large banks more rigorously and to create a credible threat of liquidation rather than, as critics contend, to institutionalize TBTF and to make small banks less competitive.

Regardless, the Dodd-Frank debate does add credence to the notion that even healthy businesses can benefit from access to alternative sources of capital, including equity-based crowdfunding. Financial turmoil and government regulation can have uncertain impacts on the traditional capital markets; funding diversification is, therefore, a prudent strategy for small businesses.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.