The Case for Financial Regulation
By Marissa Li
What’s Ahead:
Learn about the history of financial regulation in the United States and read about Marissa’s argument that we now need greater financial regulation.
From Glass-Steagall to Dodd-Frank, the United States has come a long way in terms of financial regulation. This has, in turn, ushered in a period of growth in the financial industry. The current state of financial regulation still revolves around the legacy of Dodd-Frank following the immediate aftermath of the Great Recession. Some particulars include the famous Volcker rule that banned banks from speculating with their own assets, the creation of agencies such as the Federal Deposit Insurance Corporation (FDIC) and Consumer Financial Protection Bureau (CFPB), and increased oversight over derivatives and proprietary trading. History shows us how financial regulation interacts with the markets, illustrating that we need more regulation today to evolve as the market is evolving.
The legacy of Dodd-Frank and other global reforms are credited with the swift restoration of confidence in the American financial system which can be illustrated by the V-shaped recovery of the stock market in the spring of 2020. According to the Atlantic Council, an American Atlanticist think tank, “banks were in a much better position to face the COVID-19 crisis than the 2008-09 global financial crisis [due to] substantially stronger capital and liquidity resources.” Global reforms sought to raise the capital requirement for banks and set higher liquidity standards so the economy would be able to absorb shocks without completely shutting down. Thus, the reforms enacted to provide financial stability did just that as global economies were closed rapidly due to the pandemic.
“With the recent expansion of the fintech industry, it’s clear that Congress is once again slow to catch up with the effects of technological innovation.”
Some critics of financial regulation assert that it will stifle economic growth and is simply too much red tape that puts a stranglehold on the financial system. They believe that inefficiencies in underwriting loans and general financial operations is causing more harm than good. While there may be too much red tape in any sort of regulation, an unlikely source from the Chicago Booth Review defends financial regulation, breaking with the longstanding view from the Chicago school. The author, Brian Wallheimer, a journalist at Purdue, argues that regulation actually served to improve confidence in specific aspects of finance which led to more improvement and further economic growth. Research from the Chicago Booth business found that crackdowns on insider trading and market manipulation led to increased household equity holdings by as much as 12%. Another type of regulation that requires companies to disclose their financial information, including private companies, boosted investment in those that complied as well. This implies that the path toward regulation that makes markets more transparent to average day investors lifts all who participate.
I believe that even the current financial regulation isn’t enough, especially after the trend toward deregulation during Trump’s administration. These cycles of pro-regulation and deregulation are characteristic in America’s history of financial regulation. With the recent expansion of the fintech industry, it’s clear that Congress is once again slow to catch up with the effects of technological innovation. According to Pitchbook, there’s been a total of $1.85 trillion invested in fintech so far with the future trending toward even more investment. These companies are acting in the spirit of smart regulation by making their services more accessible to people and democratizing access to financial information.
The transition of financial information to the digital space increases the risk for ever worsening data breaches. Despite this, many companies aren’t passing the tests set out by the Payment Card Industry's Data Security Standards(PCI DSS) which is the information security standard for organizations that handle credit card information. What’s even more frightening is that even companies that do are still vulnerable to hacks; the Target hack that exposed millions of customers’ credit card information was one such example. As nefarious groups improve their penetration abilities, the government has to accelerate the cybersecurity standards for these growing fintech companies.
“The solution to this isn’t deregulation as some are advocating for, it’s a case for more regulation that’s less complex.”
There also needs to be regulation aimed at limiting the influence of large financial institutions. One of the main causes of the financial crisis was the unfortunate impact few banks had on the financial industry. Visa’s $5.3 billion acquisition of Plaid was a scary moment for the debit-credit card industry as it would continue Visa’s near monopoly on that market. Only after the Department of Justice sought to sue was the deal called off. Since the choices of the DOJ are subject to the whims of the particular administration, it’s prudent that there be other independent oversight over such acquisitions in the fintech space.
There is also a serious ongoing debate about how complex financial regulation suffocates innovation as growing fintech companies often don’t have the resources to maintain top-notch compliance departments that have ballooned to millions of dollars at large financial institutions. The solution to this isn’t deregulation as some are advocating for, it’s a case for more regulation that’s less complex. Maybe that looks like creating a department within the SEC solely focused on FinTech developments. Maybe that looks like pushing the CFPB to place stronger protection on financial data. But just as the financial industry is getting disrupted, so too must financial regulation begin to face serious changes.