Taking Stock of Dodd-Frank: Hits, Misses and Unfinished Business

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David Zaring and Todd Zywicki on the Fifth Anniversary of Dodd-Frank

The fifth anniversary of the Dodd-Frank legislation is an opportune time to resume the debate on whether it has achieved or failed to meet its goal of overhauling U.S. financial regulations.

Enacted in July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was a response to the 2007-2008 financial crisis and the economic slump that followed. Critics say the legislation has ushered in excessive regulations that have shrunk the market for community banks while benefitting larger ones; driven low-income borrowers in particular to unregulated lenders, and failed to bring clarity on how it can prevent bailouts of institutions viewed as too big to fail.

But supporters contend that Dodd-Frank has made the U.S. financial system safer, enhanced consumer protection, regulated previously unregulated derivatives markets and encouraged multiple regulatory agencies to collaborate.

Wharton legal studies and business ethics professor David Zaring and Todd Zywicki, a law professor at George Mason University and executive director of its Law and Economics Center, debated the record of Dodd-Frank and discussed the tasks ahead for lawmakers and regulators on the Knowledge@Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)

A Work in Progress

Zaring described Dodd-Frank as “a work in progress” though he is “tentatively happy” with the way the statute has been implemented. “It has made the financial system safer, limited the size and scope of the largest banks, and created a new system of oversight that is affecting the way they do business today,” he said.

Zywicki, however, strongly disagreed. “If the purpose of Dodd-Frank was to permanently entrench too-big-to-fail [financial institutions], raise the cost of credit for consumers, reduce access to credit for consumers and spur a greater reliance on products like pawn shops and payday lending, then certainly Dodd-Frank achieved its purpose,” he said. “But to the extent that what Dodd-Frank intended to do was to eliminate too-big-to-fail [financial institutions], to make the system work better for consumers, to increase choice and competition, then Dodd-Frank by any measure is a miserable failure. Everything that has resulted from it is the exact opposite of what it was supposed to do.”

Unseemly Rush?

According to Zywicki, the U.S. Congress was in a hurry to craft and enact Dodd-Frank. He pointed out that a commission created to study the causes of the financial crisis released its report six months after the law was enacted. “They rushed into Dodd-Frank without having any idea of what they were doing; they never properly diagnosed the underlying causes of the crisis,” he said.

Zywicki said that strong medicine was needed in the wake of the financial crisis. “A more coherent federal regulatory regime with respect to consumer protection was one, and something needed to be done about too-big-to-fail,” he said. “Instead of thinking about things that would work, Congress created a political document, a document created by internal politics [and] power battles between politicians.”

“It has made the financial system safer, limited the size and scope of the largest banks, and created a new system of oversight that is affecting the way they do business today.” –David Zaring

Lawmakers should have explored a bankruptcy option for unviable financial institutions instead of creating the so-called Orderly Liquidation Authority, Zywicki noted. “We should have created a modern consumer protection regime rather than a regime that takes us back to the 1970s and heavy-handed command-and-control regulation that ignores the fact that we have had great changes in the Internet and information technology.”

Scoring Points

Zaring noted that Dodd-Frank addressed the too-big-to-fail question by creating the Financial Stability Oversight Council. “[This agency] has the ability to designate firms as too-big-to-fail and make them hold extra capital to make it painful to be that big,” he said. The agency ensures that different regulators in the financial system now “talk to each other,” he added, instead of the previously “balkanized” regulatory system.

Dodd-Frank also regulated derivates trading, since Congress worried that financial firms were taking big positions on those unregulated markets, Zaring continued. For consumer protection, it created a new agency — the Consumer Financial Protection Bureau (CFPB) — that is independent, he said. “In the real world in which we live, all of these contributions have had an effect,” he noted. “So far, all the signs are pretty good.”

New Frontier

Both Zywicki and Zaring agreed that future legislation is needed to fix some of Dodd-Frank’s shortcomings, even if they did not agree entirely on their nature or size.

Zywicki suggested that the CFPB be made “a regular, bipartisan agency with accountability to the democratic process.” He described the Orderly Liquidation Authority as “dead on arrival,” and doubted if it would work in practice. “Nobody seriously thinks that when the time comes, the federal government will trust that system rather than bailing out the big banks,” he said. Zaring agreed that it is not clear how the Orderly Liquidation Authority would help wind up failing banks.

Zywicki also faulted the Financial Stability Oversight Council as “a completely black-box, unaccountable process that seems to have no rules or standards in determining what systemically is risky and what isn’t.” Further, he said the financial crisis occurred despite regulators having more access to information than ever before. “It’s not a matter of information and information-sharing. There is no way that a centrally planned regulatory regime can deal with the complexities of this world. It is just naive to think that we can.”

“Dodd-Frank by any measure is a miserable failure. Everything that has resulted from it is the exact opposite of what it was supposed to do.” –Todd Zywicki

Zaring disagreed. “Our regulatory system is jerry-rigged, no question, but that doesn’t mean that it is worse than any of the alternatives,” he said. “In many ways, the response to the financial crisis in the U.S. is the envy of regulators with other financial systems in the world.”

The Next Target?

Zaring said he would like “Dodd-Frank Part II” to focus on regulating shadow banking. As examples, he cited retail consumers tapping payday loans and companies using commercial paper, asset managers, hedge funds and other new types of financing.

He also called for rules that focus on ethics. “[There is] the need for bankers’ ethics,” he said, noting that the Federal Reserve and the European Commercial Bank are focused on that aspect. He described as inadequate the rules on capital requirements and stable funding ratios designed to keep banks from failing in the event of a crisis or a shock.

“Those rules are hard requirements and focused on numbers,” Zaring explained. “Increasingly, regulators think that that’s not enough to get banks to be safe and stable — that they are going to need some commitment from bankers that they want to comply and that they are going to be a client service-driven set of institutions. They [are] trying to come up with codes of ethics for banks to adopt and take seriously.”

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