Financial Regulatory Reform and the Excesses of the Dodd-Frank Act

Abstract

The Dodd-Frank Act was enacted in 2010 in the aftermath of the 2008 financial crisis. Its purpose is to prevent another such debacle by redressing the root causes and to ensure that, if it were to recur, the financial system would recover in short order without another government bailout. But the law was created on a false premise in an act of regulatory overkill that deflected focus well beyond the calamity’s seminal cause. As a consequence, the legislation has hampered a normal economic recovery. Now reform is necessary. Dodd-Frank encompasses much more than the compromised mortgage lending standards that precipitated the crisis. In fact, it restricts some areas of financial activity that were only peripherally influential, or even unrelated. Some of the law’s strictures and mandates, as well as those of other financial regulations, were politically motivated to expand government control in the spirit of the “Never let a good crisis go to waste.” doctrine. In addition, many regulation advocates mistakenly call for even more oversight, including a return to the separation of commercial and investment banking under the erstwhile Glass-Steagall Act. Much lies in the wake of Dodd-Frank. Bank lending to small businesses has declined substantially. Market liquidity has suffered. Compliance costs squeeze bank profitability. And greater legal liability looms. All these effects militate against potential economic growth and job creation. In fact, these conditions have materially contributed to the slowest economic recovery since the Great Depression, averaging only 2% annually over eight years. Now there is a move in the Trump administration and in Congress to amend or repeal Dodd-Frank, and other financial regulation, in line with the needs of the economy and in recognition of the already restored safety of the financial system. Many areas of financial regulatory relief are under consideration. Most importantly, proposals take into account the primacy of an adequate, but not excessive, capital cushion that is commensurate with the relative risks of individual financial institutions. Ideally, required capital buffers will not unduly impinge on profitability. But bank profitability and economic growth depend on more than freedom from superfluous regulation. They also rely on effective monetary and fiscal policies that stimulate economic demand. But even with that, there is no guarantee that uncontrollable external forces in the financial markets and the global economy will not threaten financial stability. Nor is there assurance that political factors will not undermine regulatory enforcement and credit quality as they did in the run-up to the 2008 crisis.