Dodd-Frank Hits Roadblocks After Year of Progress

WASHINGTON — In the first year after passage of the Dodd-Frank Act, regulators made some progress implementing the law. Now they have essentially ground to a halt.

As they implement some of the most complex pieces of the overhaul, the agencies have had a Goldilocks complex: they're trying to get the new regulatory system just right. They want rules to be tough, but not in a way that stops business, and are aware that an industry facing an uncertain regulatory future is watching their every move.

"They know they are very much under a microscope and that they have to deliver," said Amy Friend, a managing director at Promontory Financial who worked for Sen. Chris Dodd while the law was being drafted. "That means they are going to be extra deliberate about what they're doing."

On the eve of Dodd-Frank's second anniversary, scores of rules that the law had mandated to be completed at this point are still uncompleted. They include 121 rulemakings with pending proposals, and 19 rules that have not even been proposed, according to analysis by the law firm Davis Polk & Wardwell.

Observers say a large part of the regulators' challenge is implementing a broad, general framework that Congress created without including key details.

"The regulators were handed a monumental task" with "deadlines that were impossible and random," said Margaret Tahyar, a partner at Davis Polk. "This was more than just filling in a few details. There were major components of the architecture that weren't there."

In the first 12 months following enactment, the regulators were able to check off implementation projects with earlier deadlines, such as reforms to deposit insurance pricing and the closing of the Office of Thrift Supervision. But more far-reaching provisions are still in limbo. Regulations to ban banks' proprietary trading, institute requirements for securitizers to retain risk and force lenders to ensure mortgage borrowers' ability to repay were all proposed, but none have been finalized. While the new Financial Stability Oversight Council has outlined its procedures for designating systemically important firms, no such firms have yet been designated.

For some of the bigger regulations, such as the trading ban known as the Volcker Rule, the regulators face pressure to meet the Dodd-Frank deadlines. But the lengthy proposal they issued on the rule, which included hundreds of questions for comment, also indicated their intent to methodically consider public concerns about how the ban would be implemented, almost to a fault. Critical events like the multibillion-dollar trading loss at JPMorgan Chase's London unit, which prompted further debate about the scope of the Volcker Rule, also affected their work.

"This is a search for precision in terms of 'We are going to nail every possible thing in our rule so there is no uncertainty,'" said Karen Shaw Petrou, a managing partner at Federal Financial Analytics. "They are detailed-driven to the point of incoherence."

The regulators have appeared to want to carefully consider all of the thousands of comment letters they have received on their existing proposals, even if it has meant taking longer to finish.

"When Dodd-Frank was passed, it wasn't passed with a lot of input at all from the industry," said Deborah Bailey, a former deputy director of the banking supervision and regulation division at the Federal Reserve Board, who is now a director at Deloitte & Touche. "Traditionally, financial legislation has been done in a way where not only regulators were involved in it, but the industry was also involved in it. So you had industry input into the legislation to make sure that there weren't any unintended consequences associated with the laws that were passed.

"Therefore that part of the process … to really understand the implications, I think it's naturally going to have a much slower take to it than it would have had that been during the legislative period."

It is not a lack of urgency stalling the rulemakings, many say. Instead, with the reality setting in of the magnitude and implications of many Dodd-Frank reforms, regulators have swapped immediacy for measured caution.

"The realization that 'My gosh, there's so many rules here, and we have to get them right' has taken its place, and that is not a bad thing," Friend said.

Yet there have been other impediments to the regulators moving quickly. Different agencies that must collaborate on rules have competing priorities. Some regulators have dealt with holdups in Senate confirmation of senior positions, and then the eventual change of leadership when a principal is confirmed. Agencies are also dealing with fewer budgetary resources.

"You've got these agencies that not only have their requirements to promulgate all of these rules, but they also have the same responsibilities to continue to oversee and supervise financial institutions and examinations and also finalize all of the things on Basel," Bailey said.

The pressure from members of Congress and elsewhere for agencies to provide cost-benefit analyses for certain rulemakings has also sparked a much more litigious attitude among the regulators.

"You can argue the details about what kind of cost-benefit and how it applies in a legal technical way to which agencies when, but the reality is there is this broad general principle of cost benefit analysis, which in the past has often been honored in the breach, and which the courts are telling us now needs to be truly honored," said Tahyar.

To be sure, some strides have been made over the past year.

"When we look at where we were two years ago — '08, '09 — we were really on the brink," said Cyrus Amir-Mokri, the assistant Treasury secretary for financial institutions. "Our banks didn't have enough capital. Our regulatory system was very fractured in that we didn't have any coordinating mechanisms. We didn't understand products. We didn't even have good documentation for a lot of these complex products that people were dealing with. All of that has changed. It's a work in progress, but the direction has been set, and I think that's very important to understand."

Still, regulators are generally moving at a slower pace than they did initially, and under much tougher scrutiny. For every step forward, there seem to be two steps back, and even the rules they have accomplished have come after the Dodd-Frank-required deadlines.

In December regulators unveiled a package of proposed rules to dictate how much capital banks with assets of $50 billion must hold. But, given continuing discussions in the Basel Committee on Banking Supervision on international standards, they punted on certain aspects like liquidity requirements. There is still no final rule in place.

After several attempts, the FSOC, an interagency body headed by Treasury Secretary Timothy Geithner, completed its final rule on how it would designate a non-bank financial institution as systemically risky. But no firms have yet been identified.

President Obama bypassed Congress to name Richard Cordray head of the Consumer Financial Protection Bureau, a move that is currently being challenged.

Nine of the largest banks submitted their initial so-called living wills, plans that would detail how an individual firm would be unwound in the event of a disastrous episode. But those plans provided scant details to the public. More than two dozen living-will plans are due by firms over the next year and a half.

The regulators have made little headway on other key elements of the regulatory reform effort. For example, there is no clearer path ahead now on the Volcker Rule than last year, with regulators saying they need more time to complete a final rule.

Scott Garrett, R-N.J., said the agencies are grappling with trying to implement certain provisions that are really tied to policies that have yet to be resolved by Congress. He pointed to the risk retention rule in Dodd-Frank, which generally requires securitizers to hold 5% of a loan's credit risk. But the impact of that rule, he said, relies on future decisions, such as what to do with the government-sponsored enterprises.

"They all interconnect and they all can have a damaging effect on housing mortgage finance if done incorrectly," said Garrett, who chairs the House Financial Services capital markets and GSE subcommittee. "Obviously, a more comprehensive approach to housing mortgage finance is preferable."

Meanwhile, regulators find themselves in a highly politicized environment — months before a big election — in which they receive a myriad of mixed signals.

"I think what you want the regulatory staff to do is put their heads down and do the right thing. That means listening to their colleagues, having this very healthy back-and-forth, entertaining comments that come in, and being very deliberate about what they're doing," said Friend. "But I don't think you want them to be whipsawed by all the public pronouncements about all the rules."

As a result, observers say regulators have done as well as can be expected given the circumstances. Still, some criticize the release of proposals that are too difficult to understand.

"They're huge. They're complicated," Petrou said. "You see this in the Fed meetings after you take them up one by one, and the staff drops 300-plus pages in front of the Board of Governors and they basically throw up their hands and say, 'This is what Congress told us to do. Yes. Is it tough? Yes. OK, let's put it out for comment.' "

Rep. Shelley Moore Capito, R-W.Va., who chairs the House Financial Services financial institutions and consumer credit subcommittee, said the vagueness of provisions in the legislation is largely to blame.

"It's just a mass of ill-defined and nonspecific regulations with onerous penalties, and so it leads to a lot of uncertainty," Capito said.

Some said momentum for the Dodd-Frank implementation project may simply be on the decline two years later.

"It was a year of nonactivity followed by a year of confusion," said Cornelius Hurley, director of the Morin Center for Banking and Financial Law at Boston University. "I think enthusiasm for the project has waned. At the same time, we see every day evidence of why a more aggressive response to the crisis was required in the first go around. I think every day we are realizing more that reform efforts are inadequate."

Friend said it was inconceivable for regulators to continue at their breakneck pace they followed in the first year.

"There was such tremendous pressure on all of them to get out of the box really quickly and I think the pace at which they were approaching regulation was just unsustainable," Friend said. "So in the second year, they've slowed down."

Others said it would be a mistake to move too quickly to complete such an intricate process while the regulators must continue handling their normal supervisory responsibilities.

"The criticism of the regulators being too slow is totally unwarranted," said H. Rodgin Cohen, a partner at Sullivan & Cromwell. "It should be in everybody's interest that they get it right and that takes time and effort because these are many, many complex issues. The regulators have been moving at an appropriate and measured pace. Frankly, if they were moving more quickly there would be less time to comment; there would be less time for a deliberative process at the agencies."

Rep. Barney Frank, D-Mass., the half-namesake of the reform law, agreed, and played down the missed deadlines.

"The deadlines were not firm in the sense they were basically approximations," Frank said. "Progress is going forward. I'm satisfied. The point is nothing has been undone, and nothing negative has happened because the regulations weren't in place."

Still, observers cautioned that not moving quickly enough, especially on critical pieces like enhanced prudential regulations, single counterparty credit limits and the Volcker Rule, would be detrimental.

"If you wait too long, the uncertainty mounts and mounts and mounts," Cohen said, adding that a "realistic time horizon" for completing the important regulations is "this year."

"If you didn't do that there would be a risk of loss of momentum," he said.