Central View: After Financial Reform: The Road Beyond

James Bullard

The Dodd-Frank Wall Street Reform and Consumer Protection Act is the most sweeping change in the regulatory environment for the U.S. financial sector since the Great Depression. Proponents of the reforms envision that the new law will address the root causes of the financial crisis of 2007-8 and will reduce the likelihood of future crises. Yet, with nearly 250 new rules to be written and more than 65 studies to be completed, it is simply too early to know the full impact of the legislation.

Some things are certain. The Act establishes a new Bureau of Consumer Financial Protection and a new Financial Stability Oversight Council; it also extends the supervisory authority of the Board of Governors to systemically significant financial institutions. It creates an additional orderly resolution authority for nonbank financial companies and abolishes the Office of Thrift Supervision.

The Bureau of Consumer Financial Protection is an independent bureau within the Federal Reserve System charged with examining and enforcing consumer compliance laws and regulations at the largest banks and credit unions. In addition, it is to collect, monitor and respond to complaints about consumer financial products or services as well as provide guidance on consumer financial products to traditionally underserved communities and conduct research on marketplace developments for consumer financial products. Financial firms of all sizes, except auto dealers, are subject to new regulations written by this Bureau.

Less clear is the outcome of new rule-making authority. The Financial Stability Oversight Council and the expanded supervisory authority of the Board will have the most impact on the largest financial organizations, including banks with $50 billion or more in assets and nonbank financial institutions deemed systemically significant. Some provisions of the Act, such as a new FDIC assessment that is based on bank assets rather than deposits, consumer compliance examinations by existing federal banking regulators for smaller banks and credit unions, and the grandfathering of current holdings of trust-preferred securities as capital likely will benefit or maintain the status quo for small banks. However, the implementation of other regulatory authority granted to the Bureau of Consumer Financial Protection has the potential to seriously affect the viability of community banks.

The Dodd-Frank Act does not address the resolution of Fannie Mae and Freddie Mac, the two government-sponsored enterprises that were placed into government conservatorship nearly two years ago and still hold or guarantee the majority of residential mortgage debt in the U.S. The Act does not provide any limit on taxpayer support for these institutions. How these institutions are ultimately resolved will have a significant impact on the future of mortgage finance in the U.S. Under the Act, the Treasury is required to submit by January 31, 2011, a report to Congress on options to end the conservatorships.

While the aftermath of the regulatory reform debate has unleashed a flurry of opinions and commentary on the "winners" and "losers" from this year-long process, I believe it is more important to focus on how the new environment affects incentives. Will the new environment generate more transparent financial contracts? Will it successfully constrain the ability of the managers of financial institutions to engage in inappropriately risky behavior? Will it end taxpayer bailouts of large institutions whose "bets" turn out badly? Alternatively, will it generate imaginative and successful efforts at regulatory avoidance? The answers to these questions will become apparent only with time. Only then will we know if the Act reduces the probability of a future financial crisis.

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