Five years ago, the financial crisis crushed the American economy and cost millions of Americans their livelihoods, their homes, and their savings. Two years later, passage of the Dodd-Frank Act, on July 21, 2010, laid the foundation for reform in key areas. Implementation is now at the three-year mark. Let’s take stock.
The Act created the authority to regulate Wall Street firms that pose a threat to financial stability, without regard to their corporate form, and bring shadow banking into the daylight; to wind down major firms in the event of a crisis, without feeding a panic or putting taxpayers on the hook; to attack regulatory arbitrage, restrict risky activities, regulate short-term funding markets, and beef up banking supervision; to require central clearing and exchange trading of standardized derivatives, and capital, margin and transparency throughout the market; to improve investor protections; and to establish a new Consumer Financial Protection Bureau (CFPB) to look out for the interests of American households.
In the three years since enactment, the new CFPB has been built and is helping to make the marketplace level and fair. New rules governing derivatives transactions have largely been proposed. The resolution authority and improvements to supervision are being put in place. The Financial Stability Oversight Council has begun to take on the shadow banking system by recently designating three non-bank firms—AIG, GE Capital, and Prudential—for heightened supervision. U.S. and European regulators have just come to agreement on a framework for global derivatives regulation. This week, the forces of change got a big boost when the Senate Republicans finally relented and confirmed Richard Cordray as Director of the Consumer Financial Protection Bureau.
Despite spending millions of dollars on lobbying, campaign contributions, and vexatious litigation, opponents of reform are—surprisingly to some—still losing.
The long-term view
How do we keep making progress on making the financial system fairer and safer? What should the public focus on in the months ahead?
Strong capital rules are one key to a safer system. There’s already double the amount of capital in the major firms than there was in the lead up to the financial crisis. Globally, regulators are developing more stringent risk-based standards and leverage caps for all financial institutions, and tougher rules for the biggest players. In the U.S., regulators have proposed an even stronger leverage requirement for the largest U.S. firms. And there’s been progress on the quality of capital—focusing on common equity—and on better and more comparable measures of the riskiness of assets, but more could be done to improve transparency of capital requirements and make them stronger buffers against both asset implosions and liquidity runs.
Regulators need to step up
More capital, however, is not enough to make the system more stable and fair.
The Fed needs to use its authority under Dodd-Frank to finalize its rules for tough new oversight, including requiring limits on counterparty credit exposures, and imposing a cap on the relative size of liabilities held by the largest firms. The Fed must urgently speed up reforms to short-term funding markets that were at the heart of the financial panic five years ago. It must use its authority under Dodd-Frank to bolster resiliency in clearance and settlement of foreign currency markets.
The SEC still lags far behind the CFTC in finalizing derivatives rules, and globally, promised reforms in Europe have not yet fully materialized. Apparently widespread manipulation of global rates, such as LIBOR, has not been met with the fundamental changes required to restore trust and confidence—and veracity. And five years after the money market fund industry faced a devastating run, stopped only with a $3 trillion taxpayer bailout, we still do not have fundamental reform of that sector.
Both in the U.S. and Europe, further work is needed on implementing structural reforms, such as the U.S. Volcker rule, the U.K.’s Vickers Report, and Europe’s Liikanen Group, that could reduce risks, improve oversight, and make the largest firms more readily resolvable in the event of a crisis.
And we need legislation to determine the ultimate fate of the government-sponsored enterprises in a way that protects taxpayers while assuring that the mortgage system works for American families.
So here’s the thing to remember: Financial reform is on a roll. The forces arrayed against change are losing. But that’s only because reformers are fighting every day. And if progressives lose hope, give up, and stop fighting the next day’s battle, we could find ourselves wondering why we’re in another financial crisis five years hence.