It seems like Dodd-Frank passed many moons ago. But suddenly, like talk of a war in a land without cellphones, the reports are straggling in, mostly from academics clearly attempting to free their inner Richard Posner (who is about due himself for one of his real-time dispatches on the crisis; the latest, earlier this year, was "The Crisis of Capitalist Democracy," a review of which is here). Early next month, University of Pennsylvania law professor and bankruptcy historian David Skeel will appear with "The New Financial Deal: Understanding the Dodd-Frank Act and Its (Unintended) Consequences." In January, former Federal Reserve Gov. now University of Chicago economics professor Randall Kroszner and Yale finance professor and bubble predictor Robert Shiller appear poised to publish "Reforming U.S. Financial Markets: Reflections Before and Beyond Dodd-Frank." And over at the Federalist Society, diplomat, lawyer and former White House Counsel (under George H.W. Bush) C. Boyden Gray and Washington attorney John Shu have just published "The Dodd-Frank Wall Street Reform & Consumer Protection Act of 2010: Is it Constitutional?" at the very least turning on its head the practice of short titles and long subtitles, with a very long title and a punchy subtitle.
Still, perhaps the most provocative and, in its sly academic way, entertaining and enlightening papers on this subject comes from a figure long known in banking circles, but less famous than, say, Shiller, Skeel, Kroszner or Gray (OK, none of these folks is exactly Lady Gaga): Edward Kane, a longtime finance professor at Ohio State, now at Boston College. Kane has for decades been one of the leading experts on American banking, regulation and risk; but given the wonkiness of those subjects most of the time, he's not exactly a household name. Still, a recent paper of his, which sums up his thinking over the past few years, does get your attention: "Missing Elements in U.S. Financial Reform: A Kubler-Ross Interpretation of the Inadequacy of the Dodd-Frank Act."
Kane starts off with a quote from Voltaire, then segues into Steven Colbert's use of the word "truthiness." He's not happy with the spinning and deception he sees around the legislation, notably the failure to deal with the reality and persistence of regulatory capture, which renders the president's declaration that the bill will insure that taxpayer bailouts in banking will never occur again poppycock. "The Act puts responsibility for avoiding future crises squarely on the competence and good intentions of future regulators. The presumption that regulators can succeed year after year in this task -- in the face of perverse Congressional pressures and recruitment procedures is a wishful element that could account for the President's rosy forecast."
Kane is harsh -- not unfairly -- on regulatory failures in the run-up to the crisis, particularly "the regulation-induced shadow banking system." But where most critics toss their hands up over how to reform financial regulation in a high-powered commercial democracy, Kane doggedly offers up a series of recommendations that he admits are not foolproof -- foolproof is the road to lunacy -- but which should improve the situation. "The hard-to-document nature of safety-net benefits in good times and the industry's overwhelming lobbying power provide good reason to doubt ... that the financial rules U.S. regulators are working on now will come close to meeting the aspirations that the President's signing statement sets for them."
Kane doggedly strips away what he views as the "elements of denial" (this is where Kubler-Ross comes in) in the legislation. First, there's the emphasis that risk management mistakes stemmed from private players, while ignoring the government's failures. Two, the bill ignores (and perhaps exacerbates) the misaligned incentives of regulators. Third, it ignores continuing incentives to create loopholes and opportunities for regulatory arbitrage.
He then offers solutions. Again, many of these are deeply commonsensical. And the very fact that they are illuminates the political and lobbying pressures applied to Dodd-Frank. Kane wants to create a kind of professional class of regulators, including training at their own West Point. He wants to raise their salaries (that'll be popular), provide far more detailed mission statements and oaths of office. These oaths will focus on five duties, which distantly resemble the duties of corporate executives and boards in Delaware law: vision (he means improving surveillance), prompt corrective action, efficient operation, conscientious representation, accountability. If this sounds hokey, Kane provides some bite. To insure accountability, you might have to "kill" a regulator now and again to insure accountability. He is scorching on the foolishness of an "independent" Fed remaining opaque on regulatory matters. This, he argues, is a direct affront to accountability.
Still, what's most interesting is that Kane returns to that touchstone of '30s regulatory reform, transparency. He wants to expand the information financial institutions disclose; separate the responsibility for measuring systemic risk -- what he calls "growth in the safety-net" -- from those assigned the task of doing something about it; and improving the "tools and incentives" of "safety-net managers." He wants better, more sophisticated, more flexible, more intelligent surveillance, that is disclosure. Kane wades into some real wonkiness here, though all of it is informed by long experience and, again, common sense. And, more importantly, none of it requires a radical breakup of the banks, the passage of harsh (and rigid) laws or limitations on democratic politics.
On the other hand, Kane is dismissive not only of Dodd-Frank but of the economic profession. He runs through the lessons learned in the crisis -- moral hazard, the dangers of innovation and shadow regimes, the malign effect of money politics -- then declares: "Ironically, mainstream economic models of policymaking process do not incorporate these lessons. They are built on a foundation of truthiness. Efforts to create a 'positive economics' that is independent of any particular ethical position or normative value judgments have produced a generation of economists who prefer to think of society as if it were composed of a collection of identical agents and conceive of policymakers as perfectly forward-looking and selfless idealists."
The answer is actually quite simple in intent, if difficult in practice: "To build a robust, reliable, and fair system of financial regulation, relationships between regulators and those they regulate must be revised." Kane sets a high standard of realism and pragmatism. We'll see how the rest of the Dodd-Frank commentary crew stacks up.
Robert Teitelman is editor in chief of The Deal.