If you listened only to speeches from the Presidential campaign trail, you’d come away with the strong impression that, eight years after the financial crisis, Wall Street reform has been a bust. Every Republican candidate called Dodd-Frank, the centerpiece of the Obama Administration’s reform effort, a dismal failure. Donald Trump called it “terrible”; Ted Cruz said that it had only helped “the big banks get bigger and bigger and bigger.” Hillary Clinton has been tepid in her defense of Dodd-Frank, and Bernie Sanders called it “a very modest piece of legislation” that changed little about the way the Street does business.
Tell that to the bankers. Banks performed dismally last year, and their 2016 first-quarter-earnings reports show that this one is off to an even worse start. Returns on equity have fallen. Bonuses and salaries are being slashed; in the past quarter, Goldman Sachs cut the amount it set aside for compensation by forty per cent. Payroll is down, too: banks have eliminated tens of thousands of jobs in the past couple of years and are now embarking on a new round of severe job cuts. Some of these struggles can be attributed to short-term factors, such as low interest rates and unusually volatile markets. But there’s no avoiding the deeper conclusion: regulations have simply made banking less profitable than it once was. Before the financial crisis, financial companies (not including the Federal Reserve banks) accounted for nearly thirty per cent of US corporate profits. By 2015, that number had fallen to just seventeen per cent.
“Dodd-Frank was supposed to curb certain kinds of risky behavior on Wall Street,” Mike Konczal, a fellow at the Roosevelt Institute who studies financial reform and inequality, told me. “And by that standard it’s gone very well.” Big banks now have to carry almost twice as much capital as they did before the crisis, and new Fed rules will require them to set aside another two hundred billion dollars on top of that. Those capital requirements should be even higher, but the current ones have already made the system safer. And, since the bigger the bank, the bigger the capital requirements, there has been a welcome move toward downsizing. Citigroup has shed seven hundred billion dollars in assets over the past seven years, while Goldman and Morgan Stanley have shed a quarter of their assets. JPMorgan cut assets last year to avoid a capital surcharge. And G.E. effectively got out of the financial business altogether by selling off most of G.E. Capital.
Profit-making opportunities for banks have also shrunk. Thanks in part to the new capital requirements and to new rules curbing banks’ proprietary trading, fixed-income trading has dried up, costing banks billions of dollars in revenue. Dodd-Frank has also reduced the middleman fees that banks collect-for instance, by moving much of the trading of derivatives onto the open market. More than half of credit-default swaps and seventy per cent of currency swaps now trade through a public clearinghouse. (Before the crisis, only a small percentage did.) Until recently, big banks were able to borrow money much more cheaply than small ones, because investors assumed they’d be bailed out in a crisis. But recent studies suggest that that funding advantage has nearly disappeared.
Dodd-Frank’s success is important in its own right. But it also teaches us an important lesson about regulation more generally. For decades, the debate over regulation in the US has been dominated by those who believe that, in the words of the Chicago School economist Eugene Fama, “even the best-constructed regulation is bound to fail.” As Fama put it a couple of years ago, “Eventually, the regulators get captured by the people they regulate.” Regulatory capture is always a danger. But the history of financial reform after the crisis shows that it’s not inevitable: if you have well-designed rules, and if regulators have the resources and the public support to enforce them, industry does not always win. Before Dodd-Frank became law, Wall Street lobbied furiously to emasculate it, but the attempt failed. Likewise, the banks’ efforts at softening the bill’s provisions during its implementation have often been unsuccessful. A paper by the political scientists John T. Woolley and J. Nicholas Ziegler looks in detail at the fight over derivatives-trading regulations. “Most of the industry was violently opposed to the new rules,” Ziegler told me. “But a combination of small but very engaged advocacy groups and gutsy regulators made sure they got through.”
Of course, there’s much about Wall Street that Dodd-Frank has not changed. Bankers still make absurd amounts of money. Hedge-fund and private-equity managers still benefit from the carried-interest tax loophole. The big banks, though smaller, are still too big. “If you wanted financial reform to radically downsize the financial sector, or thought it was going to make a major dent in income inequality, you’re bound to be disappointed,” Konczal says. And Dodd-Frank’s work is still unfinished: many of the rules it authorized have yet to be written, and the banks are lobbying to have them written in their favor. As Ziegler told me, “The progress that’s been made is precarious. It can be unravelled.” But precarious progress is progress. Regulation involves a constant struggle to keep rules in place and to enforce the ones that are there. Dodd-Frank shows that that struggle is not necessarily a futile one: sometimes government really does regulate business, and not the other way around. Courtesy – The New Yorker