Dodd-Frank at Three: Time to Reform the Financial Reform Act

With eager anticipation of its salutary effects on an ailing American financial system, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law on 21 July 2010. Now, three years later – and still suffering the throes of implementation – it appears that Dodd-Frank is not the great elixir that proponents claimed it would be.

The worst prescription for what currently plagues the system is to believe that Dodd-Frank is good enough and to put thoughts of financial reform behind us. Recovering from this malady will be difficult, but – given the stakes for the financial system and the businesses and individuals that it serves – it has to be worth a try.

The process of diagnosing the problem is already underway. The ranks of those who believe that Dodd-Frank descended from heaven in impeccable perfection have thinned considerably over the past few years. A glance through a 50-page technical reform bill introduced by Senator Richard Shelby (Republican, Alabama) last March should convince others that Dodd-Frank isn't the flawless piece of legislation they envisioned it to be.

Senator Shelby's bill concentrates on purely technical mistakes, but these small errors serve as mementos to the haste with which Dodd-Frank was drafted. As any lawyer knows, even missing parentheses, misspellings, and incorrect statutory crossreferences matter a great deal.

That Dodd-Frank has discrete and substantive flaws was illustrated by a bipartisan bill that passed 420 to two in the House of Representatives last month. That bill would amend Dodd-Frank to enable information-sharing among derivatives regulators – something Dodd-Frank made inexplicably difficult.

But Dodd-Frank has more fundamental problems – including the enormous powers granted to regulators and unprecedented barriers to holding those regulators accountable. It also mandates some remarkable departures from constitutional principles, not to mention the embrace of a financial system dominated by a few big financial institutions handpicked by regulators.

After diagnosing the problem, there must be the will to amputate parts of Dodd-Frank that are harmful or useless. This may be painful, but retaining unhealthy laws simply because they are already on the books is foolhardy. Recall that much of Dodd-Frank became law without a whole lot of thought.

Key congressional committees eschewed holding hearings on watershed failures of financial institutions central to the crisis, such as the breaking of the buck by the Reserve Primary Fund. Instead, Congress outsourced its investigation of the causes of the crisis to the troubled, extra-congressional Financial Crisis Inquiry Commission, which finished its report well after Dodd-Frank became law.

Legislators added or significantly modified many pieces of Dodd-Frank during late night conference sessions. Other pieces of the statute – such as the provision related to a new fiduciary duty for broker-dealers – were much longer in the making, but avoided the scrutiny that they would have gotten had they been standalone pieces of legislation.

Once legislators remove the moribund parts, future financial reform must address the problems that Dodd-Frank did not. Dodd-Frank left housing finance in the ever-tightening clutches of a government-backed system that has the unflagging support of many entrenched interests.

Reform efforts need to place the risk of loss squarely in private hands, and Congress should think more broadly about how to inoculate taxpayers against exposure to reckless risk-taking and poor decision-making in the financial system. This may include unpopular and temporarily painful measures that will force bank shareholders to pay a lot more attention to the health of their institutions than they have been accustomed to doing in the shadow of an overprotective Uncle Sam.

New regulatory agencies must be redesigned so they are transparent, politically balanced, appropriately responsive to congressional oversight, and deliberate in their decision-making.

It's hard to admit that Dodd-Frank was not a success, even though only some 40% of the rules are done. At three years old, though, Dodd-Frank has already caused a lot of tears and turmoil.

It's not too late to take a critical look at it – without the rose-colored glasses so many had on when it first became law.