A Better Model for Dodd-Frank
The basic message Common Good is trying to spread with our Start Over campaign is simple: People, not rules, make things happen.
The regulatory philosophy of the U.S. makes the flawed assumption that more specific rules lead to better results. That’s why our country now has 140 million words of federal law, or thirty thousand words for every word in the Constitution.
In reality, more specificity leads to more loopholes, unintended consequences, and most importantly, the elimination of human judgment. Instead of entrusting individuals with the responsibility to make prudent decisions based on principles established by law, our legal and regulatory system expects bureaucrats to follow the letter of the law without deviation. And lawmakers are likely to step on their own toes by creating inflexible regulatory structures that can’t keep up with changing times.
Eighteen months ago, President Obama signed the Dodd-Frank Act, a statute of some 2,300 pages intended to prevent financial sector abuses of the kind that led to the 2008 crisis. Its core strategy is to empower federal regulators to control the promulgation of risky financial instruments like derivatives. But, as David Skeel wrote last year, “the legislation merely provides a framework for achieving these objectives. It leaves nearly all of the details to financial regulators, who will be required to promulgate more than five hundred new rules.” And New York Times columnist Joe Nocera recently warned against “complexity risk,” arguing that “contradictory regulations, however well meaning, simply don’t make the system safer.”
The Dodd-Frank approach presents an opportunity and a risk. The opportunity is to show that individuals entrusted with regulating the financial sector can work most effectively when the law gives them a broad objective and the proper tools. The risk is that the law expects these regulators to achieve the objective not through careful deliberation and analysis, but by writing hundreds of new, specific rules.
Skeel observes that the new rules will work best if they are “simple and straightforward.” Let’s hope the regulators take note. But it’s hard to imagine a scheme of five hundred new rules being truly simple and adaptable. Contrast that with Britain’s Financial Services Authority, which sets out seven basic principles to guide regulators’ decisions. The principles are succinct, clear, and intuitive, and they establish a basic philosophical approach that regulators and businesses can easily understand and apply. For example, one of the principles, “Proportionality,” reads in its entirety:
The burdens or restrictions we impose on the industry should be proportionate to the benefits that are expected to result from those burdens or restrictions.
In making judgements in this area, we take into account the costs to firms and consumers. One of the main techniques we use is cost-benefit analysis of proposed regulatory requirements. This approach is shown, in particular, in the different regulatory requirements we apply to wholesale and retail markets.
Similarly, the FSA lays out eleven principles of proper business conduct in the financial sector. They include:
- “Integrity: A firm must conduct its business with integrity,”
- “Financial prudence: A firm must maintain adequate financial resources,” and
- “Relations with regulators: A firm must deal with its regulators in an open and cooperative way, and must disclose to the FSA appropriately anything relating to the firm of which the FSA would reasonably expect notice.”
Sometimes more specific rules are necessary, but for the FSA, maximizing granularity is not the default. Does that make it more difficult for the agency to ensure fairness? Well, as Clive Briault, FSA’s former managing director of retail markets, put it: “Our Principles are rules. We can take enforcement action on the basis of them; we have already done so; and we intend increasingly to do so where it is appropriate to do so.”
It’s hard to imagine those words coming from an American bureaucrat. Yet at a time when Americans are all too accustomed to regulatory failure, surely we ought to think about regulatory approaches that serve individuals and the economy instead of chasing after subsections and clauses.