As the Dodd-Frank financial reforms celebrate a fourth birthday this week, the story being told is one of regulators spinning their wheels. “Only half done,” sighs CNN Money. “Dodd-Frank's Four Years of Doing Nothing,” claims Bloomberg View. Reason’s Peter Suderman writes, “Dodd-Frank is not a law that was passed to do any specific thing, or even several specific things ... [I]t's hard not to conclude that the legislators behind the law did not really know what it was supposed to do at all.”
Don’t believe them. This past year has seen significant advances on key issues of financial reform, with at least four major wins. And crucially, the battles that still remain are coming clearly into focus.
First, banks are now required by regulators to hold higher levels of capital than had been expected. Banks hold capital to protect themselves from losses, to stay solvent during a crisis, and to make a bank failure more manageable. Though capital requirements aren’t as high as they could or should be, the consensus has distinctly moved toward high capital requirements being a central tool for putting guard rails in the financial system. And there will be additional rules later this year outlining how banks have to carry even more capital in the form of unsecured debt that provides regulators with room to maneuver in the event of a failure.
Last fall, the Commodity Futures Trading Commission oversaw the launch of the exchanges for trading derivatives. Former CFTC chairperson Brooksley Born was shoved out of government during the Clinton years, by Robert Rubin and Larry Summers, for proposing the idea, and now it is the reality of the financial markets. These “swap execution facilities” launched without a problem last fall, and in February of this year it became mandatory to trade major categories of interest rate and credit default derivatives through these exchanges.
Part of the goal of this reform was to enforce price transparency, and this is already having positive consequences. As predicted, reports are coming in that middlemen dealer firms are going to lose billions even as the volume and liquidity of the market remains the same. This is the power that regulatory-enforced price transparency can bring to a market. And as the CFTC expands to collect more data and make it public, the effect will be even stronger.
Another win was the ruling on the Volcker Rule, which separates hedge fund trading from banking activities. The rule, which had stalled throughout 2011 and 2012 as a result of internal fighting and intensive lobbying, finally was unveiled in December of last year. As Kevin Roose of New York magazine wrote, “the fact that the draft rule managed to escape the lobbying process more or less intact is actually pretty incredible.” There will be a long implementation process as regulators make calls about what falls inside and outside of the rule, but the fact that it survived this process is important.
As Ganesh Sitaraman of Center for American Progress argues, when people say "Too Big To Fail they" are really describing a bigger problem than the risk that the sudden collapse of a financial firm will cause panics and stress across the entire economy. But for that narrowest risk, the FDIC this past year started to put serious meat on the process of how it would create a death panel for a failed large financial firm. Their “single point of entry” method, which would kill the holding company while keeping the subsidiaries going, still has serious issues, but they are issues that can now be debated within a framework.
And conservatives should rejoice. I consistently hear about how Dodd-Frank is a “corporatist” bill that protects firms by labeling them systemically important. And if being seen as systemically important and subject to Dodd-Frank rules was an implicit subsidy—the “biggest kiss,” as Mitt Romney put it during the 2012 debates—then firms should be running toward the designation.
The opposite of that happened in 2013. When the insurance giant Prudential was being considered for systemically important status, instead of trying to get the status it aggressively fought it. Meanwhile, the lobbyist-driven bills in the House seek to remove parts of Dodd-Frank rather than expand or solidify it. Utilities want out from derivatives requirements, and private equity firms want out from having fraudulent activity exposed by the SEC under Dodd-Frank. These are all the opposite of what you’d expect if it was a corporatist bill.
However, for all the advances, we also saw new problems throughout the past year. The conservative goal of defunding the CFTC is starting to show real effects. There simply isn’t enough staff or funding for the CFTC to accomplish its goals, which in turn puts it under even more critical scrutiny. Even the Bipartisan Policy Center’s Financial Regulatory Reform Initiative is arguing, in their recap of the past year, that we need to independently fund these regulatory agencies rather than leave them in their current state.
Also, the issues where regulators are reluctant to take strong action are becoming increasingly apparent. As Marcus Stanley of Americans for Financial Reform told me, “regulators have not fulfilled their statutory mandates to ban incentive pay that encourages inappropriate risk-taking, impose appropriate limits on the Federal Reserve’s emergency lending powers, bring real accountability to the credit rating agencies, and simplify the structure of global Wall Street mega-banks to ensure that they can be resolved safely. Even their initial proposals in these areas are inadequate.” Whether and how Congress forces regulators to act on these key points will determine the shape of financial reform.
Meanwhile, the infighting between regulators will become more intense, as critics and conservatives move their core arguments away from the popular CFPB towards the Financial Stability Oversight Council. FSOC is already fighting to push reforms of the dangerous short-term lending facilities and require additional financial firms to follow stronger rules, and it is facing major resistance. How this plays out will determine whether or not the shadow banking industry is put into check.
People are starting to look beyond the immediate response to the financial crisis that Dodd-Frank was meant to address, towards how the financial markets work within our economy. Even President Obama is saying that we need “a banking system that is doing what it is supposed to be doing to grow the real economy” and calling for "further reforms." Issues like how financial firms own real commodities like aluminium and whether the Post Office should offer simple bank accounts blew up over the past year, and made everyone realize the battle is beyond the problems exposed by the financial crisis.
However, another interesting development is the Tea Party narrative officially absolving Wall Street from any and all dubious activity or need for reform. You can see this in Representative Jeb Hensarling's recent speech, where he mocks the idea that “an alchemy of Wall Street greed, outsized risk and massive Washington de-regulation almost blew up the planet” as false. In recent years Republicans would at least reference the idea that some reforms were needed, even if they were minimal. That is no longer in play.
Suderman and other critics are wrong in arguing that there’s no logic behind Dodd-Frank. Dodd-Frank was to port the regulatory system of banks that had kept the economy working during the Golden mid-century period over to the capital markets that have exploded in the past 30 years. This process is slowly working, in starts and stops, and the important thing is to continue to guide it going forward. It took a generation to deregulate and create this system; to put a proper system of regulations back in place won’t happen in one short period.