Happy Birthday, Dodd-Frank. You’re two years old and, like a toddler, you’re full of promise yet frustratingly, maddeningly incomplete.
Depending on one’s point view, the sweeping legislation intended to reform Wall Street — from investment banking to credit card companies — is either a draconian assault on capitalism and free markets, or a watered-down and feeble program that doesn’t go nearly far enough.
The truth, as is usually the case, probably lays somewhere in between.
Certainly, the spirit of financial system reform is a good thing. Too-big-to-fail banks threatening the stability of the global financial system with too much leverage, exotic products that no one understands and risk models that bear no resemblance to reality are something we simply can’t afford.
And we can probably all agree that sneaky credit card fees, predatory lending and fine-print rip-offs on personal finance products could do with more policing.
But the Dodd-Frank Wall Street Reform & Consumer Protection Act is hardly perfect. It’s still being rolled out. And, critically, it doesn’t go far enough in protecting the financial system from its biggest systemic risks.
Many banks, after all, are still too big to fail.
No financial institution should be so big that its collapse brings down the global financial system. Yet here were are four years after the crisis, and too-big-to-fail banks are bigger than ever. The crisis led JPMorgan Chase (NYSE:JPM) to scoop up Washington Mutual and Bear Stearns. Bank of America (NYSE:BAC) grabbed Merrill Lynch and Countrywide (much to the bank’s regret). Wells Fargo (NYSE:WFC) consumed Wachovia.
Yes, there are actually fewer, bigger players today. And more risk concentrated in a smaller number of institutions is the opposite of doing away with too-big-to-fail.
Meanwhile, when it comes to risk, banks still have a couple of years to get in compliance with the so-called Volcker Rule. The regulation’s intention is to forbid banks from using customer deposits to take speculative bets. If you’re backed by taxpayer dollars, you can’t monkey around with proprietary trading, hedge funds, in-house private equity shops or any other risky financial gunslinging.
Of course, that didn’t prevent JPM from losing $5.8 billion-and-counting on what it calls a hedge gone bad. Whether it really was a hedge — which would be permissible under the new rules — or more shenanigans by rogue actors, is very much open to debate.
But the key takeaway is that even the bank with the best risk-management on the Street shot itself in the face with complex derivatives bets.
Dodd-Frank didn’t stop that — and it won’t do so in the future, at least as it’s currently construed. As long as the incentive system on the Street rewards swinging for the fences without punishing strike outs, everyone from rank-and-file traders to CEOs will pose a threat to balance sheets, bottom lines — and taxpayers.
More promising has been the consumer protection side of Dodd-Frank. On Wednesday, the act’s two-year birthday, the nation’s consumer watchdog, which was created by the legislation, handed down its first enforcement action.
The Consumer Financial Protection Bureau grabbed a $210 million settlement from Capital One (NYSE:COF) for deceptive marketing practices. It turns out a vendor for the credit card company pressured and deceived customers into buying things like identity theft protection, hardship insurance and credit monitoring.
That first enforcement action was a good start. Regular folks need protection from rip-off products or mortgages they can’t afford. But make no mistake, the far-reaching sweep of Dodd-Frank, from investment banking to retail banking, is hurting industry revenue.
And the banks are responding by slashing jobs.
Bank of America, Citigroup (NYSE:C), Wells Fargo, Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS) have cut a total of more than 30,000 positions since last summer, by The Wall Street Journal’s reckoning.
Whether those jobs had any greater utility for society is open to question. But they were certainly critical to the people who held them.
Sweeping change, whether it’s in manufacturing, technology or financial services is always painful and, yes, destructive. And more change and destruction is coming. According to law firm Davis Polk, the 848-page Dodd-Frank law has already resulted in more than 8,800 new rules and regulations.
And the process is only 30% complete.
History will be the judge as to the wisdom and efficacy of financial reform. It will be a mixed verdict. Dodd-Frank is not perfect. No law ever is.
As of this writing, Dan Burrows held none of the securities mentioned here.