A year ago, during the first Conglomerate Masters Forum on Dodd-Frank, many of the commenters, including me, were critical of the legislation. I was not alone in my complaints that Dodd-Frank left too many important details of the legislation to be filled in over the coming years by regulators. In fact, the media and commentators had already invoked public choice critiques of Dodd-Frank. Many were particularly worried that the filling in of important details left open by the legislation would take place outside of the public glare that accompanied the congressional deliberations on the statute and provided the large Wall Street firms with another opportunity to shape the final law in their favor. This potential was heightened as memories of the financial crisis faded and the general public -- temporarily galvanized by massive financial institution bailouts into an interest in the normally-arcane topics of credit derivatives, systemic risk, and moral hazard -- turned their attention to other political issues.
An examination of theory and evidence confirms that these fears were not misplaced. Over the next few posts, I’ll use section 619 of the Dodd-Frank Act, popularly known as the “Volcker Rule,” as a case study to illustrate these points. I had hoped to be able to post a paper to SSRN detailing this data by now, but alas, I am too slow. But I’ll include in these posts a first cut of the data I’ve collected on this, with the assistance of three excellent Duke law students, Nilesh Khatri, Daniel Luna, and Robert Blaney, who have spent all summer reading public comment letters and federal agency meeting logs, rather than hanging out at the beach. Special kudos to Nilesh for his creation of spreadsheets that even I can’t mess up.
Subject to important exceptions, the Volcker Rule prohibits “banking entities” from engaging in proprietary trading and from “acquiring or retaining any equity, partnership, or other ownership interest in or sponsor[ing] a hedge fund or a private equity fund.” Both parts of the rule – the ban on proprietary trading and the restrictions on fund investment and sponsorship – are subject to substantial ambiguities that will require agency definition and rulemaking.
On the public choice critique, let me start with the theory. The political conditions surrounding the passage of Dodd-Frank were ripe for what might be termed a “responsibility-shifting delegation.” Due to negative public sentiment surrounding the financial crisis and the pubic anger over the bank bailouts that accompanied it, bank risk taking – an issue of traditionally low public salience – was temporarily transformed into an issue about which the public cared deeply, yet had little expertise or knowledge by which to judge the success of legislative outcomes. There was thus substantial public interest in the legislative process surrounding the Volcker Rule, including the various accommodations and concessions necessary to gain the votes for Dodd-Frank passage. Both the public and the press followed these developments closely, and expressed frequent concern, even outrage, at signs that the financial industry might escape the consequences of its role in precipitating the financial crisis.
Yet, these same facts suggest that lawmakers may have found it politically advantageous to delegate to agencies the authority to fill statutory gaps and ambiguities in the Volcker rule, rather than legislating with specificity these highly complex and contested provisions. The Volcker rule thus promised Congress the possibility of claiming credit for meaningful financial reform through public-interest rhetoric about preventing banks from gambling with public money, while providing the banking industry a second chance at escaping the most onerous restrictions of the Rule through successful lobbying during the rule-making process.
My remaining posts will focus on the evidence. As feared by many Dodd-Frank critics, that evidence suggests that the powerful interest groups most affected by the Volcker Rule did not waste the additional opportunities provided by the provision’s important gaps and ambiguities. Instead, as evidenced by both pubic comment letters and meeting logs, they actively lobbied agencies to adopt favorable definitions, interpretations, and exemptions.
This evidence also demonstrates a corresponding waning of public attention to and interest in the Volcker rule once the action moved to the regulatory agencies. Despite initial indications that the public interest in bank risk-taking survived into the crucial regulatory rule-making phase, a closer look reveals that these signs are misleading. Contrary to first impressions, the Volcker rule did not galvanize the public into an involvement in the gap-filling process, despite notable efforts from some public interest groups.
In my next post, I’ll be back with much more, starting with a detailed analysis of the nearly 8000 public comment letters received by the FSOC on Volcker.
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