The aftermath of the Great Recession and financial-services industry collapse provided one intriguing opportunity to settle an old argument. In the wake of the massively unpopular government bailouts, would more regulation reduce the Too Big To Fail phenomenon, or would it create all sorts of incentives that would make it worse? With Democrats in complete control of Washington, the US ended up taking the progressive choice in Dodd-Frank. Almost five years later, a new study published by the Harvard Kennedy School of Business concludes that the law has accelerated the kind of consolidation that makes the problem worse:

Interestingly, we find that community banks emerged from the financial crisis with a market share 6 percent lower, but since the second quarter of 2010 – around the time of the passage of the Dodd-Frank Act – their share of U.S. commercial banking assets has declined at a rate almost double that between the second quarters of 2006 and 2010. Particularly troubling is community banks’ declining market share in several key lending markets, their decline in small business lending volume, and the disproportionate losses being realized by particularly small community banks.

The consolidation in the financial industry has multiple drivers, but the increase since 2010 is primarily related to Dodd-Frank’s regulatory compliance costs. The extra burden is also dragging on consumer lending:

Professor Scott Shane of Case Western Reserve University recently noted in Bloomberg Businessweek that a complex web of regulatory burdens is impeding the ability of banks to lend to small businesses.82 And a recent Harvard Business School working paper coauthored by former U.S. Small Business Administrator Karen Mills reported that regulatory burdens may be impeding community banks’ ability to participate in small business lending markets.83 In the late 2014 ICBA survey, 26 percent listed “regulatory burden” as a factor hindering consumer lending.84

In addition, regulation – as opposed to market forces – appears to be an increasingly powerful force driving the growth of bank mergers. A May 2014 Wall Street Journal analysis of SNL Financial data found that community bank mergers increased 30 percent between May 2013 and May 2014.85 An October 2013 Bloomberg Businessweek story reported on banks engaging in “buying sprees” in response to regulatory pressures once they crossed the $10 billion threshold.86 A 2012 study found that community banks listed regulatory changes as the most common reason (38 percent) for M&A activity, 87 and a 2013 study concluded that the top factor (35 percent) for information technology spending on infrastructure or compliance by community banks is “leveraging data more effectively for regulatory requirements.”88 In 2011, community banks reported to the FDIC that the problem was not any single regulation, but rather the web of regulations in their totality. 89 The result? The Mercatus Center survey reported that 83 percent of small banks believe compliance costs have increased at least 5 percent since the passage of Dodd-Frank.90

Predictably, those compliance costs hit smaller institutions harder:

A 2014 Mercatus Center at George Mason University survey reported that over one-quarter of community banks (defined as those with less than $10 billion in assets) would hire new compliance or legal personnel in the next 12 months, and that another quarter were unsure about whether they would do so.67 It also found over one-third of banks had already hired new staff in order to meet new CFPB regulations. 68 Another 2014 Minneapolis Fed study highlighted the perilous consequences of regulation-driven hiring at the smallest community banks (those with less than $50 million in assets), which, according to our calculations, in Q2 2014 accounted for 11 percent, or 682, of depository institutions (consolidating at the holding company level). 69 At these institutions, the study found that hiring two additional personnel reduces median profitability by 45 basis points, resulting in one-third of these banks becoming unprofitable.70 As Fed Governor Tarullo has noted, “Any regulatory requirement is likely to be disproportionately costly for community banks, since the fixed costs associated with compliance must be spread over a smaller base of assets.”71

In other words, the massive expansion of regulation did exactly the opposite of what progressives claimed to want. It further concentrated lending, made it more difficult for small businesses to get loans, and really hammered agricultural lending. In my column for The Fiscal Times, I point out the backfire and call for free-market reforms instead:

Since passage of Dodd-Frank, the assets of small community banks have dropped 19 percent. That has had an impact on access to loans, especially in agricultural lending needed by local farmers. While demand has increased for such loans, largest bank lending in this area dropped 9.5 percent, leaving local farmers with fewer and fewer options. “Clearly, consolidation of the banking sector is not driving the largest financial institutions to engage in agricultural lending.”

It’s not just agricultural lending where the impact of regulatory-driven consolidation can be seen. In commercial and industrial lending, the larger banks have seen a boost in market share (although not the top five largest). Community banks have lost 22.5 percent of their market share in this area, with the smaller community banks dropping over 35 percent. Even in individual lending, where community banks should be able to compete on proximity to the borrowers, the larger banks have increased their market share by 36 percent, while community banks of all kinds have retreated by 8 percent — and the smaller community banks have lost 18 percent of the business.  …

If the point of Dodd-Frank was to eliminate TBTF, it’s clearly failed. Instead, what it has done is prove the point of conservatives, who have consistently argued that regulatory expansion disproportionately impacts smaller players in any market. Larger players know this and leverage their influence to get legislators to expand regulation in a way that burdens their smaller competition. Eventually, it incentivizes them to either leave the market or get swallowed up by consolidation.

If the point of Dodd-Frank was to help consumers, that too has been a failure. Consolidation reduces both choice and proximity for most consumers, and the data from Harvard amply demonstrates that in the wake of Dodd-Frank. Rather than provide more competition for service and price, consolidation has left borrowers more and more at the whims of fewer and fewer providers, and agriculture in particular has suffered the most.  About the only success we see from Dodd-Frank is the strengthening of lobbyists on Capitol Hill, particularly from Wall Street.

This should serve as an object lesson about the nature of progressive reform and its impact on markets and consumers.

Forbes columnist Carrie Sheffield says the Elizabeth Warren wing of the Democratic Party has some ‘splainin’ to to:

The prospect of a presidential candidacy by Democratic Sen. Elizabeth Warren of Massachusetts continues to tantalize the grassroots left. But she, or any other Democrat, will have to justify how Dodd-Frank financial regulations supposedly meant to help the little guy and curtail banking behemoths had the opposite effect. Numerous critics warned of this threat, confirmed by new research from the Harvard Kennedy School of Government. …

Warren’s famous “you didn’t build that” battle-cry and overt hostility toward job creators, recently channeled by presumptive nominee Hillary Clinton, was more than just a campaign slogan against mom-and-pop operations. Thanks to her heavy-handed CFPB regulations, she certainly did ensure they no, they couldn’t build that.

The 111th Congress, with Dodd-Frank, ObamaCare, and the $800 billion stimulus package, may well turn out to be the most reckless Congress in generations.