Happy Anniversary: Dodd-Frank off to a Rocky Start
Tradition in many western countries has it that paper is the customary gift for the first wedding anniversary. Arguably the product of a shotgun wedding, Dodd-Frank now crawls to its one-year anniversary as the financial reform law of the land in the U.S., but please, the last thing we need is more paper.
Not that there will likely be a lot of celebrating going on. Dodd-Frank emerged from sharp-elbowed negotiations typical of the partisan tone in Washington these days and, in 2,000-plus pages, tried to address in varying degrees of substance the root causes of the financial crisis, and the lessons learned in the aftermath. In their attempts to make the bill comprehensive, many issues got kicked to regulators to develop rules or conduct studies.
The Honeymoon Is over for Dodd-Frank
In reality, some of those issues just didn’t lend themselves well to the art of compromise: for instance, getting a handle on systemic risks provoked proprietary interests to push back on virtually every aspect of detecting and mitigating mounting risks. Turns out that being significant might play well as a marketing pitch, but as a characterization of your firm’s ability to create mayhem in tough times (a “systemically important financial institution,” or SIFI, in Dodd-Frank parlance), it isn’t exactly desirable. And the idea of lending transparency to derivatives markets and moving to exchange trading and centralized clearing sounded like a good way to address the systemic implications of counterparty risk, until hammering out the details revealed considerable reluctance from many corners to change business practices that served narrower interests well.
So the reports of massive lobbying expenses these past months in Washington aren’t especially surprising as firms dig in. Nor is the glacial pace of progress by the entities created to monitor risks to the stability of the U.S. financial system, the Financial Stability Oversight Council and Office of Financial Research, some of the more prominent offspring of this reform union.
To be sure, some good things have happened because of Dodd-Frank: the curtain has been lifted on the credit ratings agency business, and there are far fewer artificial inducements to rely on ratings enshrined in governing regulations. Lightly regulated entities with considerable market power are now required to register with the SEC. And the notion of an entity like the Office of Financial Research to serve as systemic risk sleuth is a terrific one, even if the execution is disappointing so far.
But momentum for meaningful new rules in time to protect from the next crisis is all but dead, we fear. The current U.S. fiscal crisis and the start of the political “silly season” in anticipation of the 2012 presidential election are the easiest culprits to blame. Closely related is the strict diet Congress has put regulatory and enforcement agencies (like the SEC and CFTC) on, piling on additional Dodd-Frank responsibilities but being miserly with the funds to match resources with workloads. Most troubling, we suspect the rebound in markets to their pre-crisis levels has numbed many who should know better to the urgency of finishing essential reforms.
As a result, the political tide is turning away from reform and, without loud, credible voices from those who understand that the capital markets remain susceptible to devastating shocks, the second anniversary of Dodd-Frank will offer even less to celebrate. Most urgent in our view is ramping up the Office of Financial Research’s capabilities to detect and monitor systemic pressures that potentially threaten stability, along with finalizing strategies for dealing with “too-big-to-fail” institutions both domestically and globally, and taming the over-the-counter (OTC) derivatives market. Returning these issues to the top of the political and regulatory agenda should be a top priority.
Awaken, investors, from your somewhat less alarming quarterly statements, and redouble your engagement with Washington to help counter the well funded voices for the status quo.