Friday, December 19, 2014

Dodd-Frank is Obama's most underappreciated achievement

Win McNamee

The Wall Street Reform and Consumer Protection Act (aka Dodd-Frank) turns about four years old this week, and looks likely to enter the history books as one of the most unloved major legislative actions of all time. Congressional Republicans are fanatically opposed to it, seeking every possible opportunity to repeal or undermine it. Wall Street banks despise it, and have massively shifted their campaign finance spending in favor of Republican candidates who promise to repeal or undermine it. Wall Street thinks repeal would let them take on more profitable leverage, and otherwise enhance the bottom line.

At the same time, there is zero enthusiasm among liberals about the law, certainly nothing comparable to excitement over Obamacare. It's become a nearly unquestioned dogma on the left that the Obama White House and the Tim Geithner Treasury Department that shepherded the law into existence are pawns of the big banks.

But non-specialists should at least consider the possibility that this isn't all just shadowboxing. Perhaps America's largest financial institutions know a thing or two about financial regulation, and are fighting the law because it really is making a difference.

A less financialized economy

To many observers, detailed talk about specific Dodd-Frank provisions is besides the point. The ultimate failure of the law is that it's done nothing to dethrone finance from its pride of place at the commanding heights of the American economy.

This narrative gains plausibility from the reality that Geithner and other key economic policy hands have never particularly shared this objective. And many people remember reports from 2011 suggesting that finance had bounced all the way back as a share of the economy to where it was before the crash. But last year's revisions to GDP numbersby the Commerce Department challenge this conclusion.

Finance as a share of the economy peaked in 2005, and declined with the housing bust through 2008. Then it bounced back somewhat, but suffered another setback. The magnitude of the change is not necessarily earth-shattering, but the trend toward an ever-growing financial sector really does seem to have been checked.

Less trading more lending

Shrinking overall size of finance is one thing, but financial reform was also meant to change how the sector made money. Even Obama seems to feel he's fallen short in this regard, telling Marketplace on July 3 that "more and more of the revenue generated on Wall Street is based on arbitrage — trading bets — as opposed to investing in companies that actually make something and hire people." He said he aspires to fix this, but that it's "unfinished business" and his inability to deliver on it shouldn't "detract from the important stabilization functions that Dodd-Frank were designed to address."

But Obama is being unfair to himself. He perhaps should have read Sital Patel's June 6 Marketwatch article "Banks shed jobs as fixed income revenue shrinks" (or a raft of similar stories in the financial press) about how trading revenue is falling at most major banks:


In fact, as Mark DeCambre wrote recently in Quartz the only area of robust employment growth at large financial services firms these days is for lawyers and other regulatory compliance officers.

One could, if so inclined, read these facts as an argument against Dodd-Frank. Rather than employing people to engage in lucrative trading, banks are now employing people to deal with an avalanche of red tape from regulators. But to the extent that tying up banks in red tape and getting them to do less trading is what you want to see happening, the fact that it is in fact happening is a big deal.

The saving grace for investment bankers interesting in making money is that merger and acquisition activity is booming, which generates a lot of fees. But unlike trading, this definitely qualifies as providing help to companies that actually make something and employ people.

A safer banking system

Most of all, Dodd-Frank appears to be succeeding in its core goals of making a financial crisis and a new round of massive bailouts less likely. Mike Konczal of the Roosevelt Institute recently listed four major victories in this regard:

  1. Banks must hold more capital, reducing profits but making failure less likely.
  2. Derivatives now must be traded on exchanges, creating much more clarity about banks' real risk exposure.
  3. The Volcker Rule is pushing risky trading out of the kind of financial institutions whose failures could damage the broader economy.
  4. The FDIC has created a "single point of entry" process so there is now a legally clear way to wind down a large failed bank without prompting massive runs.

It would be much too extreme to say that these four steps ensure there will be no further financial crises or bailouts. But they do substantially reduce the risks.

Unfinished business

None of this is to deny that significant unfinished business remains. One perennial source of — deserved — outrage about the financial sector actually lays outside the scope of regulation: the loophole that allows most private equity and hedge fund management fees to be taxed at a preferential rate to other labor income. Obama has pushed to close that loophole but Congress appears uninterested.

Another issue is that while Dodd-Frank does raise bank capital requirements, it probably doesn't raise them as much as it should. A third issue is funding — since the passage of the law, congressional Republicans have sought to starve the regulatory agencies of the money they need to do their job. A fourth is the continued complexity of the regulatory apparatus. Dodd-Frank ultimately chose not to tackle the bewildering alphabet soup of regulatory agencies, and the sheer quantity of interagency collaboration required to get things done has already led to many delays and could lay the groundwork for future problems. A fifth is enforcement — the Justice Department and other agencies still seem to be fairly gun shy about laying down really stiff penalties on American firms for misbehavior.

Last but by no means least, the single point of entry and other crunch-time crisis management tools included in the law have not yet been tested in practice. They look promising, but the reality is that we won't know if they really work until they are tried.

This is a long list of problems. But that's hardly unusual. Even its most enthusiastic proponents know that the Affordable Care Act didn't solve everything that ailed the American health care system. Legislation is properly judged according to what it did accomplish rather than what it didn't. And Dodd-Frank has done a tremendous amount, far more than is appreciated.

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