Securitization Reform After the Crisis: Regulation by Rulemaking or Regulation by Settlement?
45 Pages Posted: 10 Jan 2018
Date Written: January 5, 2018
This article examines the regulatory framework for securitization that has been developed in response to the financial crisis which took place one decade ago. Its thesis is that, for practical purposes, little of that reform has been imposed by the statutory rulemaking process established under the Dodd-Frank Act. Instead, the bulk of actual policymaking has occurred much more informally, through enforcement actions against large financial institutions that have resulted in a series of multi-billion dollar settlements. By pursuing a strategy of “regulation by settlement,” regulators have implicitly promulgated a novel legal prohibition on misconduct in securitization markets, roughly equivalent to a negligence standard.
The revisionist account presented in this article raises three further questions: Why did the Dodd-Frank regulations prove so ineffectual? Can regulation by settlement be justified as an adequate substitute for shortcomings in the conventional rulemaking process? And, what lies ahead for the future of securitization regulation? The suggested answers are as follows. First, that the Dodd-Frank Act missed the mark because it was premised on a flawed theory of the role that securitization played the crisis, which emphasized traditional notions of fraud rather than poor risk-management. Second, despite the heavy criticism that has been levied against federal enforcement practices following the crisis, it will be argued that when the entire set of agency-bank settlements are considered as a whole, they can been seen as imposing a Pigouvian tax on the specific market externality associated with securitization, and therefore come surprisingly close to a first-best policy intervention. Third, the rollback of Dodd-Frank that is currently being contemplated within Congress and the Trump administration will further marginalize the post-crisis rulemakings and reinforce the centrality of regulation by settlement in the securitization area. The broader picture of securitization which emerges from this article’s analysis is that of a policy space which remains poorly understood and is still in flux.
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