Dodd-Frank: accretion of power, illusion of reform.

• Author: Twight, Charlotte

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank or DFA) gained passage on the rationale that it would help the United States avoid future financial crises by creating new bureaucracies to fill regulatory gaps purportedly responsible for the crisis in 2008. This paper challenges both prongs of the crisis-prevention rationale: the "regulatory gaps" argument and the "beneficent new bureaucracies" contention. Citing pivotal DFA provisions, I describe the broad powers conferred on new federal bureaucracies: the Financial Stability Oversight Council, Office of Financial Research, and Consumer Financial Protection Bureau. I also examine changes to the federal housing finance bureaucracy made by the DFA. The goal is to clarify the unprecedented authority and reach of these new bureaucracies--the DFA's potent central core--not to analyze the statute's full sweep. The evidence provided throughout is actual statutory law enacted before and after passage of the DFA. That evidence shows that the statute, although presented as an instrument of reform, has chiefly increased government power, consistent with Robert Higgs's (1987) analysis of the link between crisis and the growth of government.

This article also identifies tactics federal officials used to make Dodd-Frank difficult and costly for the public to comprehend, resist, modify, or repeal--tactics consistent with the economic theory of "political transaction-cost manipulation." This theory explains in part the economic and political incentives that drive government officials' political behavior, policy initiatives, and regulatory and legislative language (Twight 1988, 1992, 1994, 2002). One example here is Dodd-Frank's sheer length and complexity--2,315 pages in bill form. Moreover, because the act is rife with references to other statutes, one cannot fully understand it without also researching its impacts on the laws it modifies. Yet even that research would be unavailing, for the statute empowers various governmental entities to create voluminous new regulations that ultimately will determine the law's effects, authorizing 398 separate rule makings (Davis Polk 2014, 2). Thus, the statute as passed was largely a blank check whose full impact on the economy and the public would be shaped by government officials who craft and enforce the regulations it authorizes.

A Fateful Misdiagnosis?

Although the Dodd-Frank Act of 2010 was promoted as an antidote to insufficient federal oversight, scholars have shown that it was in fact misuse of existing government power over U.S. financial institutions and housing markets that led to and exacerbated the 2008 crisis. (1) Indeed, U.S. statutory and regulatory developments over many decades had created both the governmental context and the private incentives that gave rise to the crisis (White 2008, 1). From the Federal Reserve Act (1913), the Federal Housing Administration (1934), and the Federal Deposit Insurance Corporation (FDIC), made permanent in 1935, to authorization of government-sponsored enterprises (GSEs) Fannie Mae (1938) and Freddie Mac (1970), creation of the Department of Housing and Urban Development (1965), and enactment of both the Community Reinvestment Act (1977) and the Federal Housing Enterprises Safety and Soundness Act (1992), a web of government powers over U.S. financial institutions and housing markets had emerged, powers whose exercise created public and private incentives for the imprudent borrowing and lending that undergirded the debacle in 2008.

As these laws accumulated, unforeseen consequences proliferated. Social, housing, and banking policies became intertwined. Beginning in 1992, the GSEs--whose original purpose was to provide liquidity to mortgage markets by purchasing and securitizing mortgages issued by savings and loan associations, banks, and other depository institutions--were required to purchase risky subprime or Alt-A loans in ever-increasing percentages to support federal "affordable-housing" policies (Calabria 2011). Banking institutions also had to comply with affordable-housing mandates via nonprime lending or be denied such things as the right to merge or open new branches. With pressure to issue ever more subprime loans, subprime mortgage-lending standards plunged in terms of down payment, income requirements, and credit history--the mainstays of sound mortgage lending. Further, GSE securitization of nonprime loans of varying and unascertainable quality built unprecedented risk into the mortgage-backed securities market. (2) Government policy concurrently caused certain major financial institutions' boards and major stockholders to believe that the government viewed them as "too big to fail," thus increasing the "moral hazard" they faced.

In retrospect, five partly overlapping structural elements set the stage for the crisis in 2007-2009: (1) national government controls over U.S. depository institutions and mortgage markets that encouraged imprudent risk taking; (2) implicit government guarantees of financial firms deemed "too big to fail" and perverse incentives thereby created; (3) government "affordable-housing" policies supporting home ownership despite borrowers' low incomes and poor credit histories; (4) discretionary Federal Reserve monetary policy, often supplying liquidity that sustained imprudent borrowing and lending; and (5) erosion of the rule of law arising from overbroad discretionary federal power.

I revisit these structural elements in the final section of this article, evaluating them in light of the DFA's provisions and reassessing Congress's "misdiagnosis." First, however, I examine the new entities and powers created by the DFA.

Financial Stability Oversight Council

The Dodd-Frank Act's Financial Stability Oversight Council (FSOC) is a powerful new body, chaired by the Treasury secretary, whose ten voting members include heads of the major U.S. financial regulatory entities. (3) I survey here the FSOC's statutory authority and duties, the wellspring of its nascent power.

FSOC Power and Duties: Regulating Nonbanks, Directing the Fed

Most significant is the FSOC's unprecedented authority to "identify risks to the financial stability of the United States that could arise from the material financial distress or failure, or ongoing activities, of large, interconnected bank holding companies or nonbank financial companies, or that could arise outside the financial services marketplace" (DFA 2010, [section] 112(a)(1)(A), emphasis added).

The hypothetical nature of the risks postulated in the quoted statutory language highlights the breadth of the council's power--targeting risks that "could arise," not tangible present conditions. Congress similarly charged the FSOC with "responding] to emerging threats to the stability of the United States financial system" (DFA 2010, [section] 112 (a)(1)(C), emphasis added). Thus, by statute, the scope of the council's power is made a function in part of FSOC members' idiosyncratic visions of "emerging" threats. Moreover, the council's statutory reach extends even to risks arising "outside" the financial services sphere.

The linguistic talisman, here and throughout the act, is reference to an undefined "threat to the stability of the U.S. financial system." Of course, no one would suggest that real threats be ignored: the issue is potential use of amorphous "threat" terminology as a pretext for expanding government power. As shown later, in the context of Dodd-Frank, that terminology provides a malleable concept readily used in hypothesizing "systemic risks" to the nation's financial system and creating a seemingly illimitable rationale for broadened central-government control of U.S. financial markets.

But the largest expansion of federal authority through the FSOC is the council's power over "nonbank" financial institutions, firms not previously subject to supervision by the Fed.

By statute, a "U.S. nonbank financial company" is defined--with many listed exclusions--as a company "incorporated or organized under the laws of the United States or any State; and predominantly engaged in financial activities" (DFA 2010, [section] 102 (a)(4)(B) (i), (ii)). The "predominantly engaged" criterion requires that annual gross revenues of the nonbank financial institution (and its subsidiaries) attributable to financial activities constitute 85 percent or more of the company's consolidated annual gross revenues or that the company's consolidated assets related to financial activity represent 85 percent or more of the company's annual gross revenues (DFA2010, [section] 102(a)(6)).

The definition of these nonbank financial companies thus embraces many types of financial firms not previously subject to banklike regulation--companies neither licensed as banks nor providing depository and lending services, as banks do (DFA 2010, [section] 102(a)(4)). Indeed, according to this definition, U.S. nonbank financial institutions potentially include a broad range of companies, from insurance firms, check-cashing services, payday-lending firms, securities firms, investment com panies, hedge funds, and currency exchanges, to institutional investors such as pension funds and mutual funds, among others.

The FSOC's actual power over nonbank financial institutions gives it "authority to require supervision and regulation of certain nonbank financial companies" (DFA 2010, [section] 113). With the approval of two-thirds or more of the FSOC's voting members (including an affirmative vote by the chairman), "[t]he Council ... may determine that a U.S. nonbank financial company shall be supervised by the [Federal Reserve] Board of Governors and shall be subject to prudential standards ... if the Council determines that material financial distress at the U.S. nonbank financial company, or the nature, scope, size, scale, concentration, interconnectedness, or mix of the activities of the U.S. nonbank financial...