In Financial Reform, Keep It Simple Like Glass-Steagall

Central bankers are starting to realize that complex regulation can defeat the regulation's purpose
Photograph by Henrik Sorensen

The day the Dodd-Frank financial reform bill became law in 2010, Tom Donahue of the U.S. Chamber of Commerce released a statement: The law “won’t strengthen our capital markets,” it read. “It won’t jumpstart the economy, and it won’t help create any new jobs except in government.” He was right on all three points. What he failed to point out, though, was that the companies that fund the Chamber of Commerce got exactly the law they wanted: massive, complex, and evadable.

On Wednesday night, Andrew Haldane, head of financial stability for the Bank of England, gave a speech at an awards banquet in London. Regulations and tax codes have gotten longer, he said. The Glass-Steagall Act, which reordered banking in America in 1933, was 37 pages long. Dodd-Frank runs 848 pages, or—as Haldane puts it—“more than 20 Glass-Steagalls.” The “red-tape tide” must be turned, said Haldane, for three reasons.

The Chamber of Commerce wouldn’t argue with Haldane’s first reason: Complex regulations are expensive. Tens of thousands of jobs will be dedicated to carrying out and complying with Dodd-Frank. The same day Haldane spoke, President Obama released his budget, which increased the allocation to the Securities and Exchanges Commission by 18 percent. The money will go to new staff, who will carry out new responsibilities under Dodd-Frank. More regulation means more regulators. So far everyone agrees.

Second, Haldane explained that complexity doesn’t work. “In filling in old cracks,” he said, “complex rule books tend to open up opportunities for new ones to emerge. Indeed, they may increase the likelihood of new loopholes or workarounds emerging.” Simple rules are hard to beat. Luigi Zingales, an economist with the University of Chicago, gets at this in a piece he wrote last year about how he came to admire the Glass-Steagall Act. “The simpler a rule is,” he wrote, “the fewer provisions there are and the less it costs to enforce them. The simpler it is, the easier it is for voters to understand and voice their opinions accordingly. Finally, the simpler it is, the more difficult it is for someone with vested interests to get away with distorting some obscure facet.”

Third, complexity gives an advantage to larger companies. The companies best able to find loopholes, Haldane said, are “those with the deepest pockets who can afford the most sophisticated risk-modeler, the slickest tax accountant.” Complexity, he said, acts like a regressive tax. It’s a briar patch for lawyers. It looks imposing and painful, but it’s actually not that hard to wriggle through and scamper away.

Haldane’s speech, ultimately, is a little depressing. The finance ministers and central bank governors of the Group of 20 have “committed themselves to addressing this problem,” he said. The Basel Committee on Banking Supervision is looking into it, too. Haldane offered hope only that democracies will begin to understand that complex regulation is not only burdensome, but ineffective. Simple rules are cheaper and better, though they aren’t any more likely to enjoy approval from the Chamber of Commerce because of it. Maybe the next hard-fought financial reform bill, the one that comes after the next devastating financial crisis, will get it right.

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