The Dodd-Frank Financial Reform Bill is a Valuable Step Forward

The House and Senate are poised to pass the biggest financial reform legislation since the Great Depression after their conferees agreed early Friday morning on the final form of the “Dodd-Frank” bill, as it is now named. This will be a big step forward from the current rules, which had played a major role in setting us up for the terrible financial crisis that we are still working through. There are many justified criticisms of the roughly 1500-page bill, but we must not lose sight of how much it accomplishes.

I believe that the bill, combined with regulatory changes that are in train, will move us perhaps two-thirds of the way from where we are now on financial regulation to where we should be. In the real world, this is grounds for real congratulations. It is impossible to achieve legislative perfection when transforming such a major sector of the economy. In addition to the obvious constraints created by politics and vested interests, we simply do not always know the right answers, given how complex and inter-related modern financial institutions and markets have become. Even experts legitimately disagree on important points.

Much of the media focus of late has been on a small number of contentious provisions, but the real strength of the bill is in the breadth of issues that it addresses. The financial crisis revealed flaws in a wide range of activities and this bill, largely shaped by the original Administration proposals, tackles most of them. Among other important items, it addresses: consumer protection, derivatives, securitizations, rating agency behavior, trading activities, bank compensation, rules for marketing securities, the resolution process for troubled financial institutions, and the oversight mechanisms to review financial developments that affect the system as a whole. It also provides a Congressional seal of approval for regulators to substantially toughen capital and liquidity requirements, as they already plan to do, which will be a critical part of ensuring the system’s safety. One major gap is that it does not address Fannie Mae and Freddie Mac, which contributed significantly to the crisis. However, Congress was simply not ready to address these problems seriously in the midst of the housing crisis and I believe that including reform of Fannie and Freddie in the bill would have killed the legislation altogether. It was better to secure the many necessary reforms in other parts of the financial system than to try for more than could be done in this session of Congress.

There are a number of provisions I do not like, or would like to see done differently, such as the Volcker Rule and Senator Lincoln’s provisions on separating out derivatives activities. However, the net effect of the bill should be to substantially increase the safety of the financial system, and therefore of the economy, at a cost that is reasonable. Major financial crises do serious and long-lasting harm to the economy. It is worth giving up a modest amount of economic growth in the good years to avoid the terrible downturns like the one we just experienced. I am confident that the vicious recession we just lived through would have been much milder if the Dodd-Frank bill had been in place a few years ago. The bill will not eliminate financial crises, but it will make them less frequent and considerably milder, which is all we can realistically accomplish.