Financial Reforms Are a House of Cards, Study Says

The basic suppositions behind US regulatory reforms post-financial crisis are misguided and ineffective, according to a study.

US authorities have made “incomplete diagnoses” of the causes of the crisis, authors James Barth of Auburn University, Gerard Caprio Jr. of Williams College, and Ross Levine of UC Berkeley claimed.

Instead of focusing on the systematically poor policy choices made by regulators prior to 2008, authorities stressed that US supervisory agencies lacked adequate authority over the entirety of the financial system, the study said.

And based on such misdiagnoses, subsequent reforms were not only inefficient, but also have further empowered those regulators that had failed the system. 

“Increased accountability needs to be part of the solution, but true regulatory accountability means not just more information about what regulators are doing,” the authors said.

“One of the curious features of the crisis is that the Federal Reserve, whose regulatory inaction contributed to the crisis, nonetheless was rewarded with a larger role in safeguarding systemic stability,” the authors said.

Furthermore, the paper argued that even if some of the key elements of the Dodd-Frank Act had been implemented a decade before the financial crisis, it would have done little to prevent it—a testament to its failure to address true weaknesses within the system.

“Despite Dodd-Frank’s laudable goal of empowering regulatory authorities to control systemically important non-bank financial institutions, there are many questions about whether this will fix the root causes of the regulatory failures that fostered the most recent crisis,” the study said.

Not only does it leave considerable discretion to regulators in implementing these policies, the authors contended, the vagueness of the law weakens its efficacy.

For example, the Financial Stability Oversight Council, established under Dodd-Frank, is authorized to recommend “prudential standards for systemic risk firms” to the Federal Reserve. However, the exact standards are nebulous at best, the authors said, giving power to the regulators with little accountability to the public.

“Increased accountability needs to be part of the solution, but true regulatory accountability means not just more information about what regulators are doing,” the authors said. “It also means more informed discussion of their actions and inaction.”

Expanded governmental regulatory supervision under reform laws could also “intensify moral hazard,” the paper said, as private investors are becoming less inclined to conduct their own due diligence.

Read the full paper here. 

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