Economic Prospects: Field Notes on Wall Street Reform: The Battle Continues

President Barack Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act in July 2010. Dodd-Frank is the most ambitious measure aimed at regulating U.S. financial markets since the Glass-Steagall Act was implemented in the midst of the 1930s Depression. However, it remains an open question as to whether Dodd-Frank is capable of controlling the hyper-speculative practices that produced the near-total global financial collapse of 2008–2009, which in turn brought the global economy to its knees with the Great Recession.

Dodd-Frank is a massive piece of legislation, 875 pages in length, covering a wide range of issues. These include coordinating the efforts of the Federal Reserve, Treasury, Securities and Exchange Commission (SEC), and other financial regulatory agencies to control excessive speculation; creating a consumer financial protection bureau; establishing regulatory controls on the previously unregulated hedge funds and derivative markets; and placing restrictions on big banks, like Goldman Sachs, trading on their own corporate accounts—a practice known as “proprietary trading”—when they are supposed to be focused on their clients’ interests only.

The prevailing view on the left is that Dodd-Frank was a major victory for Wall Street. There are valid reasons for progressives to reach that conclusion. The most important is that, despite its length, Dodd-Frank mostly lays out a broad regulatory framework, allowing the various regulatory agencies to settle on the details of implementation over the next few years. Both Wall Street lobbyists as well as advocates for strong regulation anticipate that the lobbyists will be able to dominate this process of detailed rulemaking. But the reality is more complex. In fact, Dodd-Frank remains a contested terrain because there are lots of areas where strong regulations can emerge through this detailed rulemaking process.

Terms of Engagement

The very fact that Dodd-Frank exists demonstrates that the glory days of financial deregulators are mercifully over for the foreseeable future. Yet Wall Street is clearly moving into the phase of regulatory rulemaking with a strong hand. The major Wall Street firms have huge budgets at their disposal to intervene at will during the process of detailed rule-setting. In addition, the regulators themselves understand that they can burnish their future private sector career prospects if they are solicitous to the concerns of Wall Street while still working for Uncle Sam.

These are unavoidable realities. But the ammunition on behalf of serious reform is also powerful. It begins with the overwhelming evidence, provided by the financial meltdown itself, that weakly regulated financial markets produce economic disasters. The final version of Dodd-Frank that was passed into law testifies to this. Despite the ambiguities included in the final law, many features of the measure were actually strengthened through the drafting process, as lobbying efforts by Americans for Financial Reform and other citizens’ groups did end up exerting influence over many important issues.

An important example is the regulations that were established around derivative markets, including the markets for options and futures contracts, swap agreements, and other complex financial instruments. The version of the bill that passed in the Senate was much tougher than the House version in requiring, for example, derivates to be traded on regulated exchanges, as opposed to being permitted to operate in unregulated, freewheeling, over-the-counter markets. Wall Street was quite displeased when, despite its intensive lobbying efforts, the final version of Dodd-Frank that emerged out of the reconciliation conference between House and Senate members ended up much closer to what the Senate had drafted.

There is another important consideration here. In fact, it is not necessary for the supporters of effective regulations to win victories on each and every rule that needs to be hammered out. Rather, reformers can achieve a great deal winning victories in a few key areas within the full expanse of Dodd-Frank. We can see this by considering one crucial case in point, the features of Dodd-Frank covering proprietary trading by the giant banks.

Taming the Banks’ Proprietary Trading Through the Volcker Rule

The...