Financial Regulation Fatigue

What’s at stake

Following the US Dodd-Frank Act and recent regulatory efforts in Europe, the way forward appears less straightforward as challenges pertaining to coordination and to “fatigue” are growing. As a recent column by Alan Greenspan illustrated, the consensus that prevailed over the last couple of years about the need for financial reform is fragile and self and light regulation advocates are staging a come back.

Greenspan on Dodd-Frank inconsistencies

Alan Greenspan re-opened the debate on financial regulation with a firm plea in favour of financial deregulation. He argues that as the Dodd Frank Act is being translated into detailed regulations, its numerous inconsistencies of which we have only seen the tip of the Iceberg will emerge. In particular, the approach doesn’t capturethe degree of global interconnectedness of recent decades, which has not been substantially altered by the crisis of 2008. For Greenspan, the act may create the largest regulatory-induced market distortion since America’s ill-fated imposition of wage and price controls in 1971. The vexing question confronting regulators is whether this rising share of finance has been a necessary condition of growth in the past half century, or coincidence. In moving forward with regulatory repair, we may have to address the as yet unproved tie between the degree of financial complexity and higher standards of living.

Clive Crook argues that the ridiculous complexity of the new regime – the US now has more regulators, not fewer – compounds the problem that Dodd-Frank fails to capture the degree of interconnectedness by making co-operation among regulators in different countries much more difficult.

GOP legislative action to repeal Dodd-Frank

Felix Salmon argues that it’s worth looking in a bit more detail at Greenspan’s nutty ramblings, because they’re representative of what much of the financial sector believes these days. The context is the GOP-controlled Congress, which has the ability to hobble or even abolish key parts of Dodd-Frank. Washington Wire reports that the Republican leadership has endorsed a bill to repeal the Dodd-Frank Act called the “Financial Takeover Repeal Act”. The gist of the argument, which can be read at repealdoddfranknow.com or Americanprosperty.org essentially revolves around the associated loss of freedom of choice and competitive disadvantage it puts on US financial institutions. The bill has little chance of passage since Democrats, who strongly supported the Dodd-Frank financial-overhaul bill last year, still control the Senate, and President Barack Obama would surely veto any repeal that reached his desk. But the symbolism is noteworthy, signaling Republican leaders believe the bill has been a political failure for the Democrats and that there are points to be scored with voters in criticizing it.

Responses to Greenspan

Barney Frank argues that until Greenspan no one had seriously suggested that we should have done nothing in response to the financial crisis. Many commentators have suggested ways in which Dodd-Frank might be improved but very few have argued that by and large (“with notably rare exceptions”) the long period of deregulation and light-touch oversightperiod of deregulation worked out fine. Frank argues that when technology can track billions of transactions in real time, a failure to pierce the opaqueness of the system and get “more than a glimpse” of the financial system is mostly a question of will, not capacity. Dodd-Frank will, for example, make the almost $600,000bn derivatives market transparent.

Ross Levine argues in a recent paper that a systemic failure of financial regulation contributed to the crisis but that the current strategy of giving existing regulatory agencies more discretionary power is dangerous. The major regulatory agencies repeatedly designed, implemented, and maintained policies that increased the fragility of the financial system and the inefficient allocation of capital. Financial regulators frequently had the power, knowledge, and time to assess the impact of their policies and reform them. But they failed to act in the public interest. History shows that relying on the angelic intentions of bureaucrats is pure folly. And, the current strategy of giving existing regulatory agencies more discretionary power — without enhancing the governance of these agencies – is playing dice with the global economy’s future.

Back in July 2010 when Dodd-Frank was passed, the Wall Street Journal had a very nice interactive graph summarizing for each category of re-regulation the problems that existed, the solutions Congress came up with and the chances these solutions will work.

The completion of the European regulatory reform agenda

Jean Claude Trichet in a recent speech in Frankfurt argues that we are now about halfway through the comprehensive reforms that the crisis has called for. We have achieved a blueprint of more stringent bank regulations that includes more loss-absorbing capital, better risk coverage and limitations for undue leverage. Countercyclical capital buffers are meant to lower pro-cyclicality. The oversight of financial institutions as well as markets and market infrastructure are being strengthened, and the organisational structure of financial supervision is being overhauled. But much remains to be done. The most important aspect is the implementation of these reforms. Moreover, the issue of systemically important financial institutions requires further reflection, and oversight of the proper functioning of financial markets in a way that avoids undue volatility, excessive influence of dominant players and oligopolistic market structures, while reinforcing transparency, needs to be addressed resolutely.

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