Reregulating and Restructuring the Financial System: Some Critical Provisions of the Dodd-Frank Act

The financial crisis of 2008 was not unforeseen: it was preceded by clear warning signals with developments during the crisis that confirmed the underlying fault lines that had emerged as changed institutions, products and practices shifted the structure of the global system over the preceding decades. The transformation from a bank-based to a market-based global system dominated by large, multinational institutions based in major developed countries had occurred with minimal adjustment to the regulatory framework and no attention to the implications of those changes for systemic soundness. Among the major indications of systemic vulnerability were the unprecedented growth of financial sectors relative to the economies in which they were located; the absence of constraints on credit growth that led to unsustainable levels of debt for households, governments, some business sectors and the financial sector itself, and the extraordinary increases in international capital flows that exacerbated the pro-cyclicality of finance in both boom and downturn. The outcome of the crisis has been deeply punishing for real sectors in many of the world’s economies and, while it has led to numerous serious efforts by public agencies and independent analysts to ascertain its causes, it has not, so far, led to an equally serious effort to address those causes in ways that will prevent a recurrence. The Dodd-Frank Act is a case in point. To many it seemed to go through the motions of a major reform effort, giving nominal recognition to problem areas without, however, confronting many of the structural issues that had caused the collapse. But Dodd-Frank is worthy of careful analysis precisely because it helps lay out the structural issues in ways that could move the reform effort in a more constructive direction. This paper will discuss two major aspects of the Dodd-Frank Act to point out how it both succeeded and failed in identifying and addressing structural faults in the global system. The success story relates to those provisions that deal with the interconnectedness of financial institutions. The failure is the Act’s reaffirmation of pro-cyclical capital requirements as the primary tool in the post-crisis regulatory framework.