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Barry Ritholtz: Don’t blame Dodd-Frank for the slow recovery

Dodd-Frank has burdened small banks – and the businesses that rely on them – much more than large businesses that have access to capital markets. Is this why we’re experiencing the slowest recovery in two generations?

So asks Peter Wallison, a scholar at the American Enterprise Institute, a conservative think tank that advocates for free markets and views government regulation with suspicion.

Nonetheless, Wallison has raised a question worth asking – and answering – since he isn’t the only one who blames Dodd-Frank for the stubbornly slow recovery from the financial crisis.

Just by way of background, Wallison was a member of the federal commission that studied the cause of the 2008 meltdown and was the lone member to lay almost all of the blame at the feet of the government-sponsored entities, Fannie Mae and Freddie Mac. Most scholars have concluded that the causes of the crisis were many – including deregulation of the sort Wallison has advocated – and his arguments have been widely disputed.

But leaving that aside, let’s spend a few minutes examining the assertion that Dodd-Frank, adopted in 2010 to lower the odds of another financial crisis, is responsible for the slow economic recovery.

Wallison’s argument goes like this: Dodd-Frank’s new and expanded compliance requirements, while manageable for big banks, are an intolerable burden for small banks, defined as those that aren’t among the U.S.’s 25 biggest lenders. In turn, these small banks are hobbled in their ability to lend to small businesses, which lack access to the capital markets that bigger companies can tap.

Small businesses are a critical engine of economic growth and thus the shortage of credit for small and fast-growing companies explains why the economic recovery is so disappointing.

Just as an aside: Let’s not even bother with the part of Wallison’s argument where he cites a study by economists Michael Bordo and Joseph Haubrich claiming “deep contractions breed strong recoveries.”

This directly flies in the face of a much more broadly researched set of studies by economists Carmen Reinhart and Kenneth Rogoff that reached the opposite conclusion – that recoveries from financial crises, and not just regular recessions, are agonizingly slow. Most of the economic community has endorsed the Reinhart-Rogoff perspective.

Also, we’ll skip the part where Wallison says “studies of Dodd-Frank’s effect have shown that the regulatory burdens imposed by that law have been particularly harsh for community banks.” Although he does make this claim, he doesn’t cite any studies backing it up and I know of no credible research that would support this assertion.

But let’s just stick with the core of Wallison’s argument: that Dodd-Frank has choked off lending by small banks to small businesses. This should be easy to verify. After all, the Federal Reserve keeps lots of data on commercial bank loans. If small-bank lending is in a funk it should show up in the numbers.

The data service of Federal Reserve Bank of St. Louis shows that small banks, after seeing loan demand plummet following the 2008 financial crisis, now are sending so-called commercial and industrial lending – in other words, credit to small businesses – to record levels.

Furthermore, in the Fed’s most recent Senior Loan Officer Opinion Survey on Bank Lending Practices, loan officers noted, “Lending standards for smaller firms, with annual sales of less than $50 million, have been gradually loosening over the past few years, and in the current survey, the majority of domestic respondents that extend loans to such firms indicated that their standards were easier than or near the midpoints of the respective ranges over the past decade.”

In other words, lending to small businesses has been easing.

There are many reasons to criticize Dodd-Frank – it is too long, too complex, difficult to implement and probably doesn’t do enough to deal with the monumental problem of too-big-to-fail banks. But the claim that it has choked off credit to small businesses as the reason for the slow economic recovery just isn’t supported by the facts.

Barry Ritholtz, a Bloomberg View columnist, is the founder of Ritholtz Wealth Management. He is a consultant at and former chief executive officer for FusionIQ, a quantitative research firm.,