When the Dodd-Frank Wall Street Reform and Consumer Protection Act took effect on July 21, 2010, it immediately caused a sharp partisan division. This staggeringly large legislation—2,300 pages—passed the House without a single Republican vote and received only three GOP votes in the Senate. Republicans saw the bill as Obamacare for the financial system, a vast and unnecessary expansion of the regulatory state.
Four years later, Dodd-Frank's pernicious effects have shown that the law's critics were, if anything, too kind. Dodd-Frank has already overwhelmed the regulatory system, stifled the financial industry, and impaired economic growth.
According to the law firm Davis, Polk & Wardell's progress report, Dodd-Frank is severely taxing the regulatory agencies that are supposed to implement it. As of July 18, only 208 of the 398 regulations required by the act have been finalized, and more than 45 percent of congressional deadlines have been missed.
The effect on the economy has been worse. A 2013 Federal Reserve Bank of Dallas study showed that the GDP recovery from the recession that ended in 2009 has been the slowest on record, 11% below the average for recoveries since 1960.
There is always a trade-off between regulation and economic growth, but Dodd-Frank—by far the most intrusive and costly financial regulation since the New Deal—placed few if any limitations on regulatory power. Written broadly and leaving regulators to fill in the details, the act has often left regulators in doubt about what Congress meant. Even after regulations have been finalized, interpreting them can be a trial. For example, the regulations implementing the inconsistent Volcker Rule, which prohibited banks and their affiliates from trading securities for their own account, took more than three years to write, but key provisions are still unclear.
These uncertainties, costs and restrictions have sapped the willingness or ability of the financial industry to take the prudent risks that economic growth requires. With many more regulations still to come, Dodd-Frank is likely to be an economic drag for many years.
None of this was necessary. The administration and Congress acted hastily. The Treasury Department sent draft legislation to Congress only a few months after taking office in 2009, and the law—spurred by a promise from then-Rep. Barney Frank for a "new New Deal"—passed a year later. The left's view had been settled: the crisis would be blamed on Wall Street greed and insufficient regulation. The act set out to implement that worldview by subjecting American finance to unprecedented government control.
It is now clear, however, that government housing policies—implemented primarily by Fannie Mae and Freddie Mac —forced a reduction in mortgage underwriting standards, which was the real cause of the crisis. The goal was to foster affordable housing for low-income and minority borrowers, but these loosened standards inevitably spread to the wider market, building an enormous housing bubble between 1997 and 2007.
By 2008 roughly 58% of all U.S. mortgages—32 million loans—were subprime or otherwise low quality. Of these 32 million loans, 76% were on the books of government agencies, primarily Fannie and Freddie, showing incontrovertibly where the demand for these loans originated. When the housing bubble burst, mortgage defaults soared to unprecedented levels. Although the left's narrative placed all blame on the private sector, these numbers show that private firms were responsible for less than a quarter of the problem.
Yet Dodd-Frank said nothing about government housing policies and ignored Fannie and Freddie. It focused on placing additional restrictions on financial firms, often for no apparent purpose other than to extend government control. For example, all bank holding companies with consolidated assets of more than $50 billion were automatically designated as systemically important financial institutions, although a bank of that size would not bring down the multitrillion-dollar U.S. financial system.
The Volcker Rule was inserted in the act, even though there is no evidence that banks trading securities for their own account had anything to do with the financial crisis.
Even the Constitution's checks and balances did not impede the left's objectives. To block Congress from limiting the Consumer Financial Protection Bureau's activities, Dodd-Frank set up the agency to be funded directly by the Federal Reserve. This is a clear evasion of the constitutional structure in which Congress appropriates funds for executive-branch operations.
Dodd-Frank also created the Financial Stability Oversight Council, consisting of the leaders of all federal financial regulators and headed by the Treasury secretary. FSOC has the extraordinary power to designate certain nonbank financial firms as systemically important financial institutions ( SIFIs ) if, in the judgment of the council, the firm's "material financial distress" would cause financial "instability." By definition, then, SIFI designation means a nonbank financial institution is "too big to fail." Although we are currently saddled (thanks to past government policies) with several enormous banks that may be too big to fail, the act gave the FSOC the power to create more too-big-to-fail institutions in other industries.
The SIFI process is underway, with AIG, Prudential Financial and GE Capital already designated. These firms are now subject to banklike regulation by the Fed—though the central bank has given no hint of what this regulation will ultimately entail.
The FSOC is now turning to asset-management firms and mutual funds, with what looks like an effort to bring large players in the capital markets and securities industry under Fed regulation. The obvious danger in subjecting the unique and innovative U.S. capital markets to banklike restrictions recently drove the House Financial Services Committee to pass a one-year moratorium on additional SIFI designations.
There is much more, but one example says it all. Several months ago J.P. Morgan Chase announced that it plans to hire 3,000 more compliance officers this year, to supplement the 7,000 brought on last year. At the same time the bank will reduce its overall head count by 5,000. Substituting employees who produce no revenue for those who do is the legacy of Dodd-Frank, and it will be with us as long as this destructive law is on the books.
Correction: Due to an editing error, an earlier version of this article misspelled the word systemically as systematically.
Mr. Wallison is a senior fellow at the American Enterprise Institute. His book on the financial crisis, "Hidden in Plain Sight: How the Government's Housing Policies Caused the Financial Crisis and Why it Can Happen Again," will be published in January by Encounter Books.