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Dodd-Frank’s Missed Opportunity: A Road Map for a More Effective Regulatory Architecture

This paper proposes a new structure for the United States financial regulatory system. To some, this may seem unnecessary after the 2010 passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), which made significant changes to the U.S. regulatory architecture following the financial crisis. In fact, Dodd-Frank focused more on expanding regulatory authority than making the overall structure more efficient or eliminating overlapping jurisdictions. As one analysis put it, Dodd-Frank “will do little to streamline the fractured financial regulatory framework.” In short, it was a missed opportunity.

The existing structure, or architecture, for regulating financial firms in the U.S. has evolved over time, largely due to ad hoc responses to financial crises. In the aftermath of the most recent crisis, Dodd-Frank continued this pattern and made some needed refinements to that structure.

These refinements include: the creation of the Financial Stability Oversight Council (FSOC) to facilitate information-sharing and coordination among the various financial regulators; the consolidation of the Office of Thrift Supervision (OTS) with the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC), and the Federal Reserve; and the establishment of a new agency dedicated solely to consumer protection, the Consumer Financial Protection Bureau (CFPB).

However, certain weaknesses of the U.S. financial regulatory architecture that were highlighted by the crisis either were not addressed or were inadequately addressed by Dodd-Frank. Today, the U.S. financial system remains too fragmented, with gaps in regulation that contribute to systemic risk and inefficiencies in both government and private markets. For example, the separation of securities and commodities regulation creates conflict between agencies and inefficiency for institutions that must comply with two sets of similar rules for similar activities. Likewise, the separate regulation of banks and their parent holding companies can produce regulatory overlap, especially in those cases in which a holding company is in essence a corporate shell for the bank.

Furthermore, the U.S. is one of the few remaining major industrialized countries that does not regulate the business of insurance on a national basis. This complicates coordination with international insurance authorities and impedes national platforms for serving consumers more effectively and efficiently. Finally, the new FSOC is a positive first step toward better regulatory coordination, but it is too large, cumbersome, and weak to effectively coordinate and rationalize the regulatory actions of independent agencies.

Past proposals for greater rationalization of the U.S. financial regulatory architecture typically have foundered as a result of three major forces:

  1. The natural resistance to changing existing regulatory agencies, both federal and state, because existing stakeholders are familiar and comfortable with the system at the time;
  2. Stakeholders unwilling to concede advantages they gain from the status quo, even if such advantages may be inefficient or lead to inequitable treatment; and
  3. Jurisdiction divided among multiple congressional committees, each of which historically has been interested in preserving its existing jurisdictional authority.

All of these factors influenced the extent to which Dodd-Frank was able to alter the U.S. financial regulatory architecture. Nonetheless, the task force believes that the financial crisis demonstrated a pressing need for more fundamental reform. Some of these reforms could be phased-in to allow stakeholders to better understand and adapt to the new structure. It is true that past and current political realities make any structural change difficult. That said, the U.S. needs a financial regulatory system that is both effective and efficient, and one that will not be a significant contributor to the next crisis.

This paper presents a road map for how to achieve a more rational and effective financial regulatory architecture over time in line with important, basic principles. These guiding principles include:

  • Clarifying the U.S. regulatory architecture to close gaps that could contribute to a future crisis or financial stress event;
  • Improving the quality of regulation and regulatory outcomes;
  • Better allocating, coordinating, and efficiently using scarce regulatory resources;
  • Ensuring the independence and authority of financial regulators to allow them to anticipate and appropriately act on threats to financial stability; and
  • Increasing the transparency and accountability of the regulatory structure.
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