Panel discusses successes and shortcomings of financial reform bill

A panel of experts convened yesterday afternoon to discuss the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act), enacted in July 2010. The Rock Center for Corporate Governance, a joint initiative of the Stanford Law School (SLS) and the Stanford Graduate School of Business (GSB), convened the panel.

Panelists included Neel Kashkari, managing director at bond house PIMCO, former assistant secretary of the Treasury and the first TARP chief; business professor Darrell Duffie and law professor Joseph Grundfest.

When asked to grade the Dodd-Frank on a scale of one to 10, with 10 most effective, Duffie and Grundfest granted the bill an “incomplete” while Kashkari rated the bill a three. All three agreed that the legislation fails to address certain important issues.

“‘Too big to fail’ is insufficiently addressed,” Kashkari said. The act “doesn’t attempt to address Fannie and Freddie, and at 2,500 pages, it’s only about 2,300 pages too long.”

The Dodd-Frank Act attempts to address the problem of “too big to fail” — the idea that certain financial institutions were so huge and systemically important that the government could not let them fail — by giving the government receivership authority.

“However, you have to separate a normal crisis from an extraordinary crisis,” Kashkari said. “In an extraordinary crisis, where the entire system is at risk, these tools can’t work, because if you wind down one institution, you risk destabilizing other institutions.”

Duffie, an expert on derivatives and the financial system, credited the Dodd-Frank Act for improvements in the safety and competition/market efficiency of derivatives transactions, the main problems of which occurred in the over-the-counter (OTC) market.

The press has probably overdone it in terms of reporting on the size of the role that derivatives actually played in the financial crisis, Duffie said.

Nonetheless, the Dodd-Frank Act made headway in requiring standard derivatives to be cleared on exchanges and to be guaranteed by clearinghouses; a new classification of derivatives exchanges, called Swap Execution Facilities, was also created for smaller order books.

“Such infrastructure improvements provide the greatest promise of improving financial regulation,” Duffie said.
The panel also discussed the issue of corporate governance and its role in the financial crisis. While all three panelists agreed that failures in corporate governance were not the main cause of the financial crisis, they disagreed on the magnitude of its contribution.

Grundfest argued that greater contributors to the crisis were information failure and the collective failure on the regulatory side in terms of risk analysis and management.

“The government of the U.S.A. in the banking sector and in the securities sector had all the necessary authority and data to prevent this crisis from happening,” Grundfest said. “But OTS [Office of Thrift Supervision]…did not understand the implications of the data it had access to.”

Kashkari, however, argued that “it’s very hard to be the one wise person in a sea of fools,” and it may be unrealistic to expect anyone to be wise in advance.

In response to a further question that it is the responsibility of regulators to anticipate asset bubbles by “[taking] away the punch bowl right when the party gets going,” Kashkari responded that every regulator lives in a political world and cannot be prescient.

“You can’t legislate wisdom,” Kashkari added.

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