Has Financial Regulation Been a Flop? (or How to Reform Dodd‐Frank)

Abstract

Recent bank regulations have imposed large compliance costs on banks of all sizes, and have increased the costs of borrowing to both consumers and companies. But in this summary of his recent book, the author argues that the problems with banking system regulation go well beyond the excessive costs. Indeed, Dodd‐Frank and other post‐crisis regulatory reforms have failed to address the major shortcomings that produced the crisis of 2007–2009. Most importantly, excessive housing finance risk was not dealt with adequately, and is already on the rise again. And prudential standards for banks, while much stricter, remain unreliable in a severe economic downturn. After providing evidence of the shortcomings of major parts of the regulatory structure created after 2008, the author points to fundamental problems in the thinking underlying the post‐crisis regulatory changes that made those reforms unlikely to succeed. Moreover, he argues that the new processes of financial regulation have fostered many abuses of the rule of law, which have politicized regulation, adding to its cost and discrediting important supervisory and regulatory agencies. The author suggests that simpler, more effective, less costly, and more respectable approaches to regulation are possible. He offers a set of principles to guide reform and proposes over 20 specific actions that would enhance the effectiveness, reduce the costs, and improve the processes of bank regulation.

An Historical Perspective on the Quest for Financial Stability and the Monetary Policy Regime

“…Debate over the causes of the 2007–2008 crisis continues. Many factors were at work, including major regulatory failure in the U.S. housing sector (Fanny Mae and Freddie Mac) encouraging risky mortgage borrowing (Rajan 2010; Poole 2017); the Fed (and other central banks) leaving its policy rate well below the Taylor Rule rate (2002–2005) for fear of a Japan-style deflation (Taylor 2007); 16 financial innovation that created derivatives; the failure of the United States and other regulators to comprehend that their regulations of the global banking system were being evaded by the creation of off balance sheet entities (Gorton 2010; Calomiris 2017); a global savings glut (Bernanke 2005); and greed and malfeasance by many financial sector players (Gorton 2012; Blinder 2015).…”

“…40One tool of macro prudential policy—raising capital requirements—many argue may be the most effective and simple way to improve financial stability. See Admati and Hellweg (2013) and Calomiris (2017). …”