Friday, September 28, 2012

What's Up With the Dodd-Frank Legislation?

Back in July 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act. The difficulty with the law has always been that while it was fairly clear on its goals, it did not specify how to reach those goals--instead turning over that task to current and newly-created regulatory agencies.  If you're looking for an update on how the law is proceeding, a good starting point is the Third Quarter 2012 issue of Economic Perspectives, published by the Federal Reserve Bank of Chicago, which has six articles on the Dodd-Frank legislation.

Douglas D. Evanoff and William F. Moeller offer an overview of the goals and approach of the law in their opening piece (footnotes and citations omitted):

"The stated goals of the act were to provide for financial regulatory reform, to protect consumers
and investors, to put an end to too-big-to-fail, to regulate the over-the-counter (OTC) derivatives markets, to prevent another financial crisis, and for other purposes. ... Implementation of Dodd–Frank requires the development of some 250 new regulatory rules and various mandated studies. There is also the need to introduce and staff a number of new entities (bureaus, offices, and councils) with responsibility to study, evaluate, and  promote consumer protection and financial stability. Additionally, there is a mandate for regulators to identify and increase regulatory scrutiny of systemically important institutions.  ... Two years into the implementation of the act, much has been done, but much remains to be done."

How are those rules coming along? The law firm of Davis Polk & Wardwell publishes a regular Dodd-Frank report. The September 2012 edition summarizes:

  • "As of September 4, 2012, a total of 237 Dodd-Frank rulemaking requirement deadlines have
    passed. This is 59.5% of the 398 total rulemaking requirements, and 84.6% of the 280
    rulemaking requirements with specified deadlines.
  • "Of these 237 passed deadlines, 145 (61.2%) have been missed and 92 (38.8%) have been
    met with finalized rules. Regulators have not yet released proposals for 31 of the 145 missed
  • "Of the 398 total rulemaking requirements, 131 (32.9%) have been met with finalized rules and
    rules have been proposed that would meet 135 (33.9%) more. Rules have not yet been
    proposed to meet 132 (33.2%) rulemaking requirements.
The July 2010 Davis Polk update--the two-year anniversary of the legislation--offers some additional detail: "The two years since Dodd-Frank’s passage have seen 848 pages of statutory text expand to 8,843 pages of regulations. Already at almost a 1:10 page ratio, this staggering number represents
only 30% of required rulemaking contained within Dodd-Frank, affecting every area of the financial markets and involving over a dozen Federal agencies."

It's important to  recognize that writing a new regulation isn't as simple as, well, just writing it. Instead, there is often first an in-house study, followed by a draft regulation, which then is open to public comments, and then can revised, and eventually at some point a new regulation is created. It's not unusual for a regulation to get dozens or hundreds of detailed public comments.

This blizzard of evolving rules has to create considerable uncertainty in the financial sector. Matthew Richardson discusses the complexities of one particular issue in his contribution to the Chicago Fed publication. He picks one example: the problem that many banks made very low-quality subprime mortgage loans. What does the Dodd-Frank legislation do about this basic issue? As he describes, the act: 1) Sets up a Consumer Finance Protection Bureau in title X to deal with misleading products; 2)
Imposes particular underwriting standards for residential mortgages; 3) Requires firms performing securitization to retain at least 5 percent of the credit risk; and 4) Iincreases regulation of credit rating agencies. Each of these tasks requires detailed rulemaking. And as Richardson points out, "with all of these new provisions, the act does not even address what we at NYU Stern consider to be a primary fault for the poor quality of loans—namely, the mispriced government guarantees in the system that led to price distortions and an excessive buildup of leverage and risky credit."

I'm skeptical of anyone who has strong opinions about the Dodd-Frank legislation, because here we are more than two years later, less than halfway toward figuring out what rules the legislation will actually put in place. Wayne A. Abernethy of the American Bankers Association is one of the authors in the Chicago Fed symposium. Yes, he is speaking for the bankers' point of view. But his judgement about the overall process seems fair to me:

"At least in the financial regulatory history of the United States, there has never been anything like it. I have seen no definitive count of the number of regulations that the Dodd–Frank Act calls forth. The numbers seem to range between 250 and 400—numbers so large that they are numbing. It all defies hyperbole. The Fair and Accurate Credit Transactions Act, adopted in 2003, astonished the financial industry with more than a dozen significant new regulations to be written. ...

"One of the most common criticisms of Dodd–Frank implementation has been a lack of order and coordination in the regulatory process. Instead, the Dodd–Frank Act has succeeded in replacing the financial crisis with a regulatory crisis.  ... As agencies are grappling with impossible rulemaking tasks, most of them are also engaged in major structural reorganizations and shifts in the areas of responsibility. ... Nothing like this has ever been tried before in the history of the United States. Writing 400 financial regulations of the highest significance and the greatest complexity in a couple of years has clearly been too much to expect. ... Getting on with the work to end our self-inflicted regulatory crisis should be among the highest priorities."
 I'm someone who believes that financial regulation needed shaking up. Many of the broad goals of the Dodd-Frank legislation make sense to me: rethinking bank and regulation to deal with macroeconomic risk, not just the risk of an individual institution going broke; figuring out better ways to shut down even large financial institutions when needed; and better regulation of certain financial instruments like credit default swaps and repo agreements; a closer look at technologies that allow ultra-high-speed financial trading; and others.

The Dodd-Frank legislation is almost not a law in the conventional meaning of the term, because it mostly isn't about actual specific activities that are prohibited. Instead, it's about handing over the difficult problems to regulators and telling them to fix it. I'm not sure there was an easy alternative to this regulatory approach: the idea of Congress trying to debate, say, appropriate regulation of the over-the-counter swaps market is not an encouraging thought. But stating a goal is not the same as solving a problem. The passage of Dodd-Frank, in and of  itself, didn't solve any problems.