It has been more than five years since the financial crisis began and more than two years since the passage of the legislative response, the Dodd-Frank Wall Street Reform and Consumer Protection Act.
The nature and magnitude of the effects of the largest piece of financial legislation in generations will become clearer as regulators exercise the broad discretion given them under the act. Regulators’ efforts at implementation are far from complete, with many of the rules still unwritten and others not yet in effect. Regardless of how the rules are written, the act will certainly have far-reaching effects on the financial system and our economy.
As is typical of crisis legislation, Dodd-Frank included many provisions created in haste and many other provisions drafted before the crisis for which the act provided a convenient legislative vehicle. Even as the law was being passed, its proponents acknowledged its imperfections. In the years since the law’s passage, the fundamental flaws with the legislation have become more evident. Dodd-Frank not only failed effectively and holistically to respond to the crisis, but it also gives rise to a whole new set of problems that could overshadow the act’s good elements and lay the groundwork for a future financial crisis.
Many of the provisions in Dodd-Frank are entirely unrelated to the crisis. Other provisions, while purportedly solutions to real problems that emerged in the crisis, could serve to exacerbate those problems. The most striking omission of the act was its failure even to attempt to reform the broken housing-finance system in the U.S. The failure to act was not for want of workable solutions, but was a result of the interest special-interest groups have in maintaining the status quo.
Dodd-Frank’s proponents portray it as a solution to the “too-big-to-fail” problem that led to the massive bailouts during the financial crisis. A closer look at Dodd-Frank suggests that it not only failed to solve the “too-big-to fail problem”, but it also institutionalized the problem by allowing for the designation of systemically important firms, concentrating risk in a new set of large, interconnected derivatives clearinghouses, and deepening the government’s involvement in the mortgage market.
The companion of Dodd-Frank’s entrenchment of big financial companies is its adverse effect on small ones. With its numerous and incomprehensible complexities, Dodd-Frank gives big banks a competitive edge over their smaller rivals, who are less able to hire the lawyers and compliance personnel necessary to advise on complying with the law in the most cost-effective manner. The effects on small banks may be one of the most profound unintended consequences of a law designed to rein in big banks, but only time will tell.
Dodd-Frank creates a regulatory system that suppresses market discipline in favor of regulatory expertise and broad regulatory authority. Congress left key decisions to regulators; it afforded them tremendous discretion to define the limits of their own authority and places unrealistic expectations upon them. The underlying assumption that regulators can effectively micromanage the market is flawed. Giving regulators more levers to pull and buttons to push with respect to the financial system only creates a false sense of security. The new regulatory powers come with few meaningful accountability checks.
So much of the decision-making was left to regulators that the full implications of the law may not be known for years. Although the implementation process is not keeping pace with statutory requirements, adverse consequences for consumers are already coming to light. Consumers increasingly will face a one-size-fits-all market that costs more and offers fewer choices. Another less obvious ramification of Dodd-Frank is that it distracts regulators from their core missions by blithely sending them down the hazy trail of systemic risk, a trail entirely devoid of meaningful markers.
