As the new Congress gets to work, it will have to contend with the failures and unfinished business of the past. Financial regulation is one area rife with such failures and omissions. Most notably — as described in Dodd-Frank: What it Does and Why It’s Flawed, a new book released by the Mercatus Center at George Mason University — Dodd-Frank dramatically and dangerously missed the mark on its intended goals. Rather than averting future financial crises, Dodd-Frank invites trouble by creating new too-big-to-fail entities and relying on overwhelmed regulators to keep tabs on them.
Dodd-Frank is as much a disappointment for what it did not do as for what it did do. As the new Congress draws up its agenda, the following omissions might be a good place to look for financial reform ideas:
1.) It Didn’t Reform the Housing Finance System — Despite the clear role that government-sponsored enterprises played in the subprime bubble and ensuing crisis, Dodd-Frank leaves Fannie Mae and Freddie Mac untouched. Taxpayers are still on the hook for most U.S. mortgages.
2.) It Didn’t Merge the SEC and the CFTC — The jurisdictions of the SEC (Securities and Exchange Commission) and the CFTC (Commodity Futures Trading Commission) overlap significantly. Dodd-Frank only heightens the overlap by giving the two commissions shared authority over derivatives. A merger would reduce regulatory duplication, lower regulatory costs, and curb wasteful interagency miscommunication.
3.) It Didn’t Improve the Bankruptcy Code — Dodd-Frank created a new regime for troubled financial firms instead of reforming the bankruptcy code so it would work more smoothly and quickly for large financial companies.
4.) It Didn’t Eliminate the Federal Reserve’s Regulatory Role — Under Dodd-Frank, the Fed gained more regulatory powers. The Fed should be divested of regulatory responsibilities so that it can concentrate on monetary policy.
5.) It Didn’t Promote Private Sector Risk Monitoring — Measures should be taken to increase shareholders’ and creditors’ incentives to monitor and constrain the risk of financial institutions. Reducing deposit insurance and reintroducing double liability, which permits bank shareholders to be called upon in times of crisis to provide additional money to banks, would be one way to increase private risk monitoring.
6.) It Didn’t Effectively Constrain Future Bailouts — Although Dodd-Frank tightened constraints on future bailouts, even greater constraints are needed on the design of and accountability for emergency government rescue programs. Clear, credible constraints would limit moral hazard and lessen the likelihood of harmful government intervention.
7.) It Didn’t Reform Money Market Funds — A run on money market funds during the crisis prompted the government to put a temporary taxpayer-backed insurance program in place. Dodd-Frank avoided the subject. Sensible, workable reforms are needed.
8.) It Didn’t Reform the Repo and Securities Lending Markets — Dodd-Frank failed to address the repo (repurchase agreement) and securities lending markets, which played a substantial role in the financial crisis. Financial firms relied heavily on the repo market, which offers very short-term secured financing. During the crisis, the inability to roll over repo funding wreaked havoc at financial firms, and AIG’s massive, troubled securities lending program contributed substantially to its failure.
9.) It Didn’t Improve Capital Regulation — Rather than taking a fresh approach to capital regulation, Dodd-Frank perpetuates the approach that helped to lay the groundwork for the financial crisis. Dodd-Frank should have established straightforward capital regulations that are less susceptible to manipulation and less likely to encourage the financial industry to concentrate its assets in homogenous, risky securities.
10.) It Didn’t Effectively Sever Government Support for Credit Rating Agencies — Dodd-Frank took the positive step of removing rating agency references from statutes and regulations, but it should also have dismantled the government’s rating agency certification system. Instead, it gave the SEC more power to approve or disapprove rating agencies, thus cementing the relationship between the government and approved rating agencies.
Hester Peirce is a senior scholar at the Mercatus Center and the co-author of the book Dodd-Frank: What It Does and Why It’s Flawed. She served as a senior counsel on the minority staff of the Senate Banking Committee during the drafting of Dodd-Frank.
