Two years after the passage of Dodd-Frank, I think it is fair to say the landmark financial reform legislation has not inspired a lot of love. Free-market types naturally recoil from its enormity—the tome weighs in at 2,319 pages—and see it as a full-employment act for lawyers and compliance consultants. And there is much to be said for this point of view. The much unloved Sarbanes-Oxley Act weighed in at just 66 pages, and even President Obama’s complex health care bill was slimmer by some 200 pages.
Even political liberals and financial institutions that originally supported it are down on Dodd-Frank. Business interests have called its Volcker Rule unintelligible, as the recent flap over JP Morgan’s botched trade, which might have been permitted under Volcker, confirms. And the pro-Obama administration Economist magazine has questioned the wisdom of a law whose cost induces banks to reduce customer service through massive layoffs of bankers while increasing compliance staff; liberal blogger Walter Russell Mead writes of Dodd-Frank that “the medicine is worse than the disease” and should be repealed and replaced.
Our cover story (“Dodd-Frank’s Many Questions”) does not say what would constitute the perfect financial reform legislation. Rather, financial analyst, author and Manhattan Institute scholar Nicole Gelinas simply asks, literally, dozens of good questions the legislation still has not answered two years on.
In an effort to contribute to the debate, I would like to propose a few principles that I believe should inform the crafting or revision of regulation of this kind.
1. Micromanagement does not work. The most ambitious legislation cannot pair one regulator for every corporate employee. Rather, a blitz of rules will result in excessive costs that adversely impact markets and the economy. Post-Enron Sarbox legislation did not prevent Lehman Brothers or MF Global, but has cost business over $1 trillion that otherwise might have been channeled into productive activities.
2. Incentives do work: Shareholders with money on the line will be far more effective at policing (certain kinds of) unwanted behavior. Good regulation will therefore impose high transparency requirements; sunshine is a powerful disinfectant.
3. Focus on enforcement: What’s the use of millions of costly rules, if they are not enforced? Simpler rules but swifter enforcement are more effective. Bernie Madoff’s phony trades went undetected for decades, at great cost to investors and to public confidence. Make the criminals pay a price early and often.
4. Market discipline is not enough: Listen up, free enterprise advocates. While lamenting the heavy hand of government, we should never lose sight of the fact that regulation—good regulation—is vital. Next time an earthquake kills tens of thousands of people in Turkey, Haiti or China, remember their earthquakes are no stronger than ours but our building codes are far mightier. These countries deal with the costly aftermath of such crises long after the builders of shoddy structures have taken their money and run. So too American taxpayers should not be left holding the bag while corporate fat cats spend their bonuses in offshore havens.
We need sound rules. Until we get them, Nicole Gelinas’ good questions are worth far more than Dodd-Frank’s bad answers.