Dodd-Frank Is a Pigouvian Regulation

By Levine, Aaron M.; Macey, Joshua C. | The Yale Law Journal, March 2018 | Go to article overview

Dodd-Frank Is a Pigouvian Regulation


Levine, Aaron M., Macey, Joshua C., The Yale Law Journal


NOTE CONTENTS  INTRODUCTION                                                  1339  I. TWO THEORIES OF                                            1345    REGULATION    A. Command-and-Control Regulations                         1346    B. Market-Based Incentives                                 1348 II. ENDING TOO BIG TO FAIL                                    1352     A. The Too Big To Fail Problem                            1352     B. Dodd-Frank's Command-and-Control Response to Too Big   1355     To Fail     C. Critiques of Dodd-Frank's Response to Too Big To Fail  1360 III. DODD-FRANK IS A PIGOUVIAN REGULATION                     1363      A. A Pigouvian Theory of Dodd-Frank                      1364      B. Methodology                                           1367      C. The Pigouvian Findings                                1369         l. Divesting Commodities Holdings                     1370         2. Shedding of SIFI Designation by Nonbank Firms      1381            a. GECC's Response                                 1383            b. AIG's Response                                  1390            c. MetLife's Response                              1393            d. Prudential's Response                           1395         3. Reducing Systemic Risk                             1397 IV. THE BENEFITS OF PIGOUVIAN REGULATIONS                     1401     A. Regulatory Flexibility                                 1402     B. Informational Advantages                               1405     C. Allocating Responsibility                              1406     D. Political Feasibility                                  1407 V. PIGOUVIAN REGULATIONS                                      1408    A. Regulatory Arbitrage                                    1409    B. Black Swan Events                                       1412    C. Structural Limitations                                  1413 CONCLUSION                                                    1415 

INTRODUCTION

On April 13, 2016, the Federal Deposit Insurance Corporation (FDIC)--the agency tasked with overseeing the liquidation of systemically important financial institutions (SIFIs) during a financial crisis (1)--convened a meeting to discuss Dodd-Frank Wall Street Reform and Consumer Protection Act's (Dodd-Frank) bankruptcy regime. During the meeting, Vice Chair Thomas Hoenig noted that Dodd-Frank had failed to achieve its primary goal of ending the problem of "too big to fail"--the idea that some financial institutions are so important to the broader financial system that the government could never allow them to go bankrupt. Observing that banks are "larger, more complicated, and more interconnected" than they were before the financial crisis of 2007-2008, Hoenig concluded that not a single SIFI had shown that it could "address all phases of a successful bankruptcy if its failure were imminent." (2) On the same day, he issued a statement lamenting that "[t]he goal to end too big to fail and protect the American taxpayer by ending bailouts remains just that: only a goal." (3)

Hoenig's statements reflect the academic and political consensus: scholars and politicians from both sides of the aisle agree that Dodd-Frank has in many ways entrenched--not ended--too big to fail. (4) Although commentators recognize that Dodd-Frank has reduced systemic risk in the financial system, (5) many fear that another financial crisis would still force Congress to choose between bailing out a SIFI or allowing a recession. (6) What is more, some scholars have suggested that Dodd-Frank's regulatory costs have actually compounded the too big to fail problem. Professor Roberta Romano, for example, has argued that Dodd-Frank mandates the adoption of "costly and burdensome regulations, many totally unrelated to the financial crisis, while failing to address key factors widely acknowledged to have contributed to the financial crisis." (7) As a result, she believes that "[Dodd-Frank] has not resolved the 'too-big-to-fail' syndrome. …

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