Financial Reform Progress: Cause for Considerable Celebration and Some Concern

The Dodd-Frank Act was signed in 2010, over four years ago, and it remains a work in progress as regulators try to implement its provisions. They are also pledged to meet various globally agreed guidelines. Looking back over the past four years there is cause for considerable celebration and some concern.

We should all be celebrating the fact that the financial sector is much safer than it was at the time of the crisis, largely because financial institutions now hold more capital, have bigger reserves of liquid assets and rely less on short-term funding. In addition, great progress has been made by the FDIC in figuring out how to manage the failure of a large institution while avoiding the systemic problems that occurred in the crisis. In their approach, the costs of the failure are borne by the owners and funders of the bank and not by taxpayers. Further, there is greater transparency around derivatives trading and most such trades are made on exchanges or clearing houses. The Consumer Financial Protection Bureau has begun policing financial products to avoid the kind of abusive lending that occurred in the crisis.

There is cause for concern because our regulatory system is still fragmented, which reduces its effectiveness and increases the regulatory burden. One reason the implementation of Dodd-Frank has been so slow is that different regulators cannot agree. The Financial Stability Oversight Council was created in Dodd-Frank to foster cooperation, but it has been largely ineffective in ending turf wars and disagreements.

What of the future? Republicans did not support Dodd-Frank and have taken votes to repeal it but the chances are they will not try repeal again, even though they have control of the Senate. In any case, repeal is not going to happen as long as Obama is President and so for the next two years the real question is whether we will simply see fighting between the White House and Congress or whether there is willingness to deal with some of the problems in financial regulation in a cooperative manner.

While many observers predict nothing but stalemate and conflict, there are some hopeful signs. When Dodd-Frank was passed in 2010, several amendments were added to the bill, basically to garner sufficient votes to pass it but not because they really made sense. One of these was the Collins amendment, which has straitjacketed the Federal Reserve as it tackles its assigned task of overseeing large insurance companies. Even Senator Collins has argued that her amendment is not working as she planned and this amendment has now been modified with bipartisan support. Another positive development is contained in the appropriations bill agreed to in the lame duck Congress and now signed by the President. First it essentially repeals the Lincoln amendment, also called the “push-out rule” because it requires financial institutions to create separate legal entities for derivatives or swaps trading. Like Collins, it was added to Dodd-Frank as a way to get enough votes but regulators have made no attempt to implement it in the four plus years since the Act’s passage. While the “push-out rule” sounds good because we do not want banks to use their government-insured deposit base to speculate in risky derivatives, in practice it would be ineffective because the bank parent company would have to take financial responsibility for its swaps business even if it were a separate legal entity (something we saw in the crisis). The Lincoln amendment is unnecessary because regulators already have the tools they need to regulate the derivatives markets. Interest rate and currency swaps are actually not that risky and did fine during the financial crisis. They are a normal and integral part of banking services to companies. Another plus of the spending bill is that it provides sharply increased funding for the CFTC and the SEC, the two agencies that have responsibility for regulating derivatives and swaps trading. This increased funding will add to financial stability.

While there are these hopeful signs, the potential for gridlock is great. The left in the Democratic party led by Senator Warren, had a strongly negative reaction to the modification of the push-out rule, and they are likely to oppose any other attempt to adjust Dodd-Frank, claiming that such changes are giveaways to big banks. New York Times op-eds have also denounced the change. See Teresa Tritch, The Opinion Pages, December 9, 2014 and Paul Krugman’s column on December 14, 2014, who described the change as “Wall Street’s Revenge.” There were also some negative reactions from critics on the right. It is unfortunate that such a sensible policy adjustment should provoke such reactions.

The most we can hope for over the next two years are incremental improvements. It may be possible to clear out some of the dead wood that clutters Dodd-Frank, and that would be helpful. Following the elections in 2016, everything will be up for grabs. Fortunately, whatever the rhetoric turns out to be, it is likely that either a Republican or a Democratic President will see the value in the improvements that have been made in financial regulation since the crisis, and will keep these provisions in place.