How Financial Reform Became a Fiasco

Three years ago this summer, President Barack Obama enacted the biggest overhaul of American financial regulation since FDR signed the 1933 Securities Act and the 1934 Securities Exchange Act into law in the wake of the 1929 market crash.

Three years later, the law’s not working; indeed, it’s not doing much of anything. But neither the right nor the left is seizing the opportunity to bash the president and the Democratic Congress that passed the bill for its failure—and prospects for Dodd-Frank reform in the near future are dim.

Dodd-Frank was one of Obama’s signature first-term achievements. On July 21, 2010, Obama said that the law, named after Senator Chris Dodd and Rep. Barney Frank, fixed a longstanding deficiency: “For years, our financial sector was governed by antiquated and poorly enforced rules” that endangered the economy and “left taxpayers on the hook if a big bank or financial institution ever failed.”

The Dodd-Frank law, Obama added, would “bring the shadowy deals that caused the crisis into the light of day and … put a stop to taxpayer bailouts once and for all.” He said he was proud of Congress for having passed the law despite “the furious lobbying of an array of powerful interest groups” backed by House Republicans. Standing behind the president were purported victims of bad financial firms, to remind the citizenry that the new law wouldn’t govern only complex transactions such as over-the-counter derivatives but also relatively straightforward markets such as credit cards and payday loans.

Three years later, Dodd-Frank is the law of the land—but not the rule of the land. The law depended on regulators from the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), the new Consumer Financial Protection Bureau (CFPB) and other federal bodies to create hundreds of new rules about everything from restricting derivatives trades to approving new mortgages. Each rule, in turn, requires regulators to solicit comments from the public, including financial representatives, review the comments and ensure that the rule doesn’t conflict with an existing rule or law. Dodd-Frank established specific deadlines by which the regulators were supposed to get this work done.

But regulators have missed deadline after deadline as the rule-making process has become mired in chaos. As the Davis Polk law firm reported in July, of the 398 total rules that Dodd Frank law requires, only 155—or 38.9%—have been finalized. A full 31.9% have not even been proposed. Accomplishments so far have been fraught with uncertainty and delays, as well. “Of … 279 passed deadlines,” the lawyers reported, “175 (62.7%) have been missed.”

The delays have spurred one of Dodd-Frank’s champions, former Federal Reserve Chairman Paul Volcker, to speak up. Volcker had a particular stake in the law succeeding after early 2010. In January of that year, the president, responding to criticism that he wasn’t being tough enough on the banks, amended his early regulatory proposal to add something “simple and common-sense,” called the “Volcker Rule.” Upon the economist’s advice, the president would ask Congress to prohibit banks that have access to federal deposit insurance from engaging in proprietary trading or making speculative bets. The idea was that banks shouldn’t use taxpayer money to speculate.

Three years along, though, regulators have had trouble finalizing the details of this seemingly straightforward notion. The dallying prompted Volcker himself to tell interviewer Charlie Rose in May that, even with a complicated law, “it shouldn’t take three years to make a regulation.” Volcker added that the failure to implement Dodd-Frank is emblematic of a “big lack of confidence and lack of trust [in] government” on the part of the public. “Part of this is the feeling that the government isn’t doing as well as it should be in implementing policies,” Volcker said, chalking the problem up to bureaucratic infighting. “We have five or six agencies that have some responsibility for regulating banks,” he added. “They “all have their own mandates, all have their own turf to defend.”

Congress itself has joined in piling on the regulators. In early 2012, when critics pointed out the Volcker Rule might not have prohibited JPMorgan Chase from engaging its “whale” trades in London, Sen. Carl Levin shot back that the problem was not the law but that regulators were too slow: “If this law were in effect … I believe that these trades violated” it, he said. In December, in one of eight hearings the House Financial Services Committee has held on Dodd-Frank in the past year alone, New Jersey Rep. Scott Garrett said that regulators have exhibited “a refusal to follow explicit Congressional intent” in some matters, helping to make derivatives regulation, for one thing, “somewhat of a train wreck.”

Presidential Inaction

Obama himself has stayed quiet. Mired in the IRS Tea Party scandal and messy foreign-policy questions, he hasn’t put forward much of a domestic agenda at all for his second term. Any such agenda certainly won’t include revisiting a topic in which he never showed much interest in the first place (the events of 2008, remember, pushed him into taking on Wall Street as part of his first election).

Moreover, Obama doubtless knows that revisiting Dodd-Frank—and effectively admitting that he didn’t really fix Wall Street—puts him and other Democrats in political peril. One of the points of the Occupy Wall Street protests in 2011, after all, was that Obama didn’t fix Wall Street. Obama may be hoping that Wall Street stays quiet for the next three years and that any blow-ups will be on the next president’s watch.

More worrisome for the nation’s financial markets, though, is the fact that prominent Republicans, too, have been mum. Dodd-Frank’s quagmire is an opportunity for GOP leaders to point out: The problem isn’t the regulators, but the law itself.

After 2008, Congress and the president needed to do two things: put consistent capital requirements across financial institutions and across financial products so that the financial system had the ability to absorb losses without melting down, and, relatedly, repeal the 2000 law that prevented regulators from overseeing over-the-counter derivatives so that the regulators could impose similar rules in that marketplace, preventing a future AIG rescue. Instead, Americans got an 848-page (small-print version) behemoth of a law that did everything but the first thing and added unnecessary complexities to the second.

One of the law’s two fatal flaws was to assume that a complex financial system needs equally complex financial regulations, when the antidote is the opposite. A complex system needs simple rules. On America’s roads, you can go an infinite number of places for an infinite number of reasons, good, bad and indifferent—but you must stop at red lights, no excuses.