Democrats’ overhaul of the financial regulatory regime was signed into law one year ago Thursday. The very capable Roya Wolverson at Curious Capitalist is a skeptic. “Is the financial system any safer? Not likely,” she writes, listing half a dozen or so reasons Dodd-Frank has been ineffective in its first year on the books. I’m not sure they all hold up.
Roya’s opening argument: “There are two dozen bills in Congress aiming to do away with parts of Dodd-Frank.” Two dozen or two hundred, none of these bills pass the sniff test in a Democratic Senate and President Obama has issued explicit veto threats against every last one. Now, there’s a chance that both Obama and the Democratic majority in the upper chamber fall in 2012. Some aspects of Dodd-Frank might come under fire in that case, but it’s a longish shot and solid public support for the law might limit the scaleback. Remember that in Paul Ryan’s Ayn Rand fantasy budget, Dodd-Frank skated untouched except for the resolution authority, and the hyper-conservative House has yet to hold a single vote on any of these partial repeal bills.
Next point: “Many of the rules mandated by the law haven’t even been written.” For those unfamiliar with the process, laws don’t magically become applicable when Presidents sign them. Officials at the agencies in charge of implementation and enforcement have to lock themselves in a room and try to figure out what exactly the wise gumflappers on Capitol Hill intended when they wrote a law, and translate that into workable guidelines. Rules often run 30 times the length of the original legislation, and for many elements of financial reform, moving parts, deep complexity and unprecedented mandates make such rule-writing a difficult task. These things take time.
But wait, you say. It’s not just taking a long time. It’s taking way longer than they said it would: “The SEC has missed more than 75% of its Dodd-Frank rulemaking deadlines, while the CFTC has missed 88%.” That federal bureaucrats underestimate the time it takes to complete tasks hardly qualifies as surprising, but fair enough. The SEC and CFTC have been charged with creating a cleared marketplace for derivatives out of thin air. There’s no existing infrastructure. Zip. And, as Roya points out, there’s a budget squeeze on. The CFTC guys trying to set up a system that can monitor trillions of dollars in complex financial instruments are taking the Megabus (!) between Washington and New York City. It’s a wonder they’ve met a single deadline. This is a real problem and one of and easiest things to fix (give them money) in Dodd-Frank’s implementation.
Moving on: “Dodd-Frank’s ‘say-on-pay’ rule, which aimed to rein in outlandish executive pay packages at big corporations, has been a flop,” Roya writes. One might challenge the premise here: The goal of say-on-pay was to give stockholders a voice on compensation. If they’re choosing to continue lucrative pay, who’s to say it’s a flop? As Roya writes, “most shareholders casting a vote are institutional investors who don’t want to rock the boat on trivial matters like executive pay so long as the stock price is still headed up.” Well, a lot of stock prices are going up! If markets tumble again and a bunch of execs end up looking like egg-faced buffoons, the investors might decided it’s time to rock the boat and slash pay.
Onward: “Lax mortgage lending was central to the financial crisis, but Dodd-Frank doesn’t even dabble with the fate of Fannie and Freddie.” Sigh. I hate to even begin to re-litigate this one, but let’s try to be quick: Fannie and Freddie didn’t cause the financial crisis. They were scaling back securitization in the key period between 2004 and 2006 when Wall Street banks started hyperinflating the housing bubble and churning out monstrous amounts of gilded garbage. Yes, the GSEs are problematic and they need to be wound down and Dodd-Frank kicked the can down the road with a study, but you can’t say Dodd-Frank is failing because Fan and Fred are still standing. Treasury delivered a report that offered a few different options to close up shop. The ball is now in Congress’s court.
A similar note: “A rule aimed at making mortgage lending safer may require private banks to hold onto 5% of mortgage-backed deals for home loans in which down payment are less than 20%. But one important yet overlooked detail is that government-backed lenders Fannie and Freddie would be exempt.” Damn those GSEs! Wait, all private banks are going to have to keep some skin in the game when they dole out less-than-ironclad loans? That sounds a lot safer than the pre-Dodd-Frank status quo, when they were repackaging scandalously unsound debt, declaring it golden and selling it off without holding any of the risk on their books.
I would actually add one point in favor of Roya’s overall argument. The Consumer Financial Protection Bureau, a significant if sometimes overstated leg of Dodd-Frank, officially opens its doors on Thursday. The consumer agency will be able to police banks, but it won’t be able to finalize rules or do anything about non-bank outfits like sketchy payday lenders until it has a confirmed director. President Obama, who waited until four days before the CFPB ‘s opening date to nominate someone, shares some responsibility, but the lion’s share lies with Senate Republicans, who’ve pledged to block any and all nominees until the CFPB is restructured and dragged into the congressional appropriations process, where they can try to slash its budget.
Now let’s return to the original question: One year after Dodd-Frank, are markets safer or not? Say on pay, Fannie and Freddie and the CFPB are all only marginal factors in the safety of the market. Repeal bills in Congress aren’t a factor at all. Banks are deleveraging. They’re being forced to carry more high-quality capital in reserve and hold onto pieces of the risky home loans that cross their desks. The FDIC’s orderly liquidation authority, a new power to seize and liquidate systemically important non-bank firms if they begin to teeter, is being established. Megabanks are being forced to plan out how they might unwind in the event of disaster. Top regulators are sitting down together and thinking about systemic risk and ways to identify it. These things have the potential to be more than marginal.
Everything in Dodd-Frank deserves a healthy dose of skepticism. Much of its safeguards rely on the foresight and ingenuity of financial regulators and, let’s be honest, that’s never been much to trade on. But, on balance, is the approach to financial risk really no better than when Dodd-Frank was signed? I’m not convinced.