Revisiting Dodd-Frank

Abstract

Dodd-Frank is a sprawling law, many pieces of which are unrelated to any financial crisis — past or future. What unifies the disparate pieces is an unquestioning faith in regulatory omniscience and broad grants of power to these infallible regulators. The law calls on regulators to step in where the rest of us — individuals, firms, and nongovernmental institutions — are supposedly destined to fail, namely, to identify and address all systemic and a wide array of nonsystemic risks. In giving such heavy responsibilities to regulators, Dodd-Frank’s drafters overlooked the fact that precrisis regulators missed risks and that precrisis regulatory design contributed to the buildup of risk. By giving regulators an outsized role, Dodd-Frank suppresses the market’s intrinsic disciplining mechanisms and builds bailout expectations. Revisiting Dodd-Frank thus requires a marked change in perspective — a shift away from the comforting but ineffective “entrust the financial system to the skilled hands of the all-knowing regulators” approach to financial regulation, as well as a piece-by-piece substantive overhaul.