Dodd-Frank Is a Pigouvian Regulation
80 Pages Posted: 29 Mar 2018
Date Written: February 15, 2018
Almost eight years after the passage of Dodd-Frank, financial institutions remain large, complex, and interconnected. Academics and policymakers across the ideological spectrum largely agree that Dodd-Frank has imposed substantial compliance costs on systematically important financial institutions (SIFIs) without solving the problem that they are too big to fail. This Note argues that Dodd-Frank’s compliance costs have actually served an important regulatory purpose. By analyzing the spinoffs and divestitures that have occurred at eleven SIFIs since Dodd-Frank went into effect in 2010, this Note documents the extent to which the Act’s compliance costs have led SIFIs to shed business lines of their own accord. The data reveal that regulators can adjust Dodd-Frank’s costs in response to the perceived riskiness of specific business units, and that SIFIs can respond to these adjustments by divesting the business lines that caused their compliance costs to increase—that is, SIFIs’ riskiest lines of business. In this way, Dodd-Frank has had an effect analogous to that of a Pigouvian tax—what we call a “Pigouvian regulation.” Furthermore, because Dodd-Frank grants regulators discretion to ramp up (or down) these compliance costs over time, it provides them with powerful tools to incentivize SIFIs to become less systemically important. We therefore conclude that Dodd-Frank’s compliance costs are not a mere ancillary effect of the law, but rather support the Act’s core purpose by empowering regulators to force SIFIs to divest themselves of their riskiest assets. In doing so, regulators can—and have—made financial institutions safer.
Keywords: Banking, Financial Regulation, Securities Regulation, Dodd-Frank, Administrative Law
JEL Classification: G, K, P
Suggested Citation: Suggested Citation