Three Weeks Into Dodd-Frank and the Banks are Still Open

Following weeks of rancorous debate in Congress and a hurried reconciliation process, the President signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law on July 21 (PDF download). The President’s signature ushers in far-reaching changes to the nation's financial system that, in many respects, will not be fully understood – in Washington as much as on Wall Street or Main Street – for many years.

Details of the law aside, its passage heralds a reversal of long-term deregulation and harkens a medium-term outlook characterized by more aggressive enforcement. The civil fraud case against Goldman Sachs, while controversial in its mid-July settlement, is just one example of how federal agencies have been emboldened by the changing winds in Washington. Just yesterday, on August 10, the FDIC announced the creation of the Office of Complex Financial Institutions (see the press release). The new office "will perform continuous review and oversight of bank holding companies with more than $100 billion in assets." As for how it will go about fulfilling this mandate, little is known at this time.

With the overtly political phase of the financial reform debate behind us, a host of relatively more opaque regulatory processes will now begin to clarify how Dodd-Frank will function in practice. This clarification will take years and making sense of the new law will be a daunting task, both for regulators and the firms they oversee. With this in mind, Harvey Pitt, former chairman of the Securities and Exchange Commission, described the bill as "the Lawyers' and Consultants' Full Employment Act of 2010." We need not share Mr. Pitt’s cynicism. With an arguably more constructive perspective, FDIC Chairman Sheila Bair offered that "the responsibility now shifts to regulators to implement this law in a manner that is aligned with its principles."

In the final weeks of the reconciliation process, many of the bill's most divisive provisions fell victim to the procedural need for 60 affirmative votes in the Senate. In the end, a number of senators on the winning side concluded that while the bill was not perfect, it was the best that could be passed. Senator Dodd himself conceded the need for compromise: "It is not a perfect bill, I will be the first to admit that." Of course, opponents of the bill conclude that it will raise the cost of credit to a degree that will impinge on American competitiveness. But this view is not universally held amongst Republicans. Hank Paulson, the former Treasury secretary and now a fellow at Johns Hopkins, opined in The Wall Street Journal that "[s]ome argue higher capital and liquidity cushion requirements will slow economic growth. That's short-sighted. ... Higher capital and liquidity requirements will give us more stable long-term growth."

In remarks following the Senate vote, the president went much further than Mr. Paulson. He was unequivocal in his view that the recession "was the result of recklessness and irresponsibility in certain corners of Wall Street that infected the entire economy." He went on to state that "because of this reform, the American people will never again be asked to foot the bill for Wall Street's mistakes."

It is unrealistic to think that Dodd-Frank will forever insulate the economy from the costs of broad financial distress. Of course, we can certainly appreciate the desire to reassure the American public that Dodd-Frank will usher in a period of greater financial market and economic stability. But to suggest that we have conclusively identified and corrected the market imperfections that lead to systemic financial crises is unwarranted at best. At worst, it resonates with the same self-confidence that has allowed financial crises to visit economies over and over in the early modern and modern periods.

For the intrepid amongst us, a reading of the Act reveals that it does indeed hold the potential to ameliorate a number of the most obvious failings of the financial system. At the same time, it is sometimes so vague that it opens the door to a regulatory regime that may prove ruinous to entrepreneurship in credit markets as well as traditional commercial real estate financing. Patience is the order of the day: only time, and the outcome of considerable lobbying, will tell how the law will manifest in practice.