In the wake of the worst financial crisis since the Great Depression, America’s confidence in the U.S. government’s ability to regulate big banks and insurance conglomerates has been severely shaken.
Stories of impropriety, fraud and rampant greed on Wall Street have fueled the call for meaningful reform of the nation’s financial regulation system. Congress took note. And in July, after months of contentious, politicized debate, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act—the Dodd-Frank Act for short.
Six months later, the question is: Can the Dodd-Frank Act make good on its promise to prevent the next collapse and put an end to government bailouts of private institutions?
In his book, “The New Financial Deal: Understanding the Dodd-Frank Act And Its (Unintended) Consequences,” David Skeel, the S. Samuel Arsht Professor of Corporate Law at Penn Law School, presents a critical analysis of the 2,319-page landmark legislation. Unlike the critics who label the Dodd-Frank Act “an incoherent mess,” Skeel asserts that the strategy of the Act is clear.
“Its first objective is to limit the risk of contemporary finance—what critics often call the shadow banking system; and the second is to limit the damage caused by the failure of a large financial institution,” he says.
The Dodd-Frank Act introduces new regulatory structures for the trade of financial derivatives, or contracts, requiring they be publicly exchanged, a way of increasing transparency while reducing the risk of a collapse. Financial institutions most likely to cause system-wide problems if they fail also are subject to more intensive regulation. Hedge funds must now be registered.
These reforms, Skeel says, could prove beneficial.
However, he is also troubled by a consistent theme he sees in the legislation: government partnering with the largest Wall Street banks. The law creates special regulatory oversight for a “club” of about 30 super banks, financial institutions deemed too large to fail. “Unlike in the New Deal, there is no serious effort to break the largest of these banks up or to meaningfully scale them down,” he says.
While proponents of the legislation backed greater oversight of the Wall Street giants, the creation of a class of financial institutions that receive special treatment worries Skeel. Government regulators have great discretion on how they enforce the new rules, and there will be opportunities for negotiating with the heads of the largest banks.
The ultimate effect, he predicts, is the financial landscape will continue to be dominated by a few, large institutions that will “bend to the will of the government when asked to do so in return for being able to dominate American finance.” In such an environment, Skeel argues, it’s likely we’ll see more government bailouts in the future.
That shouldn’t come as much of a surprise, he says, since the principal authors of the reform legislation—including Treasury Secretary Timothy Geithner and Federal Reserve Chair Ben Bernanke—also crafted the policy of bailing out imperiled financial institutions AIG, Citigroup and other Wall Street titans.
“This was a way to give them the tools they wish they would have had in 2008,” Skeel says.
While calling the bank-government partnerships created by the Dodd-Frank Act “disturbing,” Skeel also identifies several aspects of the legislation that could “genuinely improve” the regulatory landscape. One example, the new Consumer Financial Protection Bureau, will serve as a public watchdog with respect to credit card and mortgage lending practices.
Skeel concludes the Dodd-Frank Act will likely shape what the American financial system looks like for decades, much like the Securities Acts of 1933 and 1934 and New Deal reforms that followed the Great Depression. He advocates for simple bankruptcy reforms that could help reduce the bank-government partnership concerns and serve as a viable alternative to bailouts.
“I wish I could say that the new regulatory regime will be as successful as the New Deal legislation it is designed to update,” he writes. “But I fear it won’t be. Unless its most dangerous features are arrested, the legislation could permanently ensconce the worst tendencies of the regulatory interventions during the recent crisis as long-term regulatory policy.”
Originally published on February 3, 2011