Is the Dodd-Frank Act Responsible for the Economy’s Slow Recovery from the Financial Crisis and the Ensuing Recession?

Special Publications | Financial Crisis


Friday, November 20, 2015
by Peter J. Wallison

Abstract

Since the financial crisis of 2008 and the ensuing recession, the U.S. economy has experienced a historically slow recovery. This paper argues that the reason for the slow recovery is the Dodd-Frank Act, enacted in 2010, which placed heavy regulatory costs and new restrictive lending standards on small banks. This in turn reduced the ability of these banks to finance small businesses, particularly the start-up businesses which are the engine of employment and economic growth. Large businesses have not been subject to the same restrictions because they have access to the capital markets, and their growth has been in line with prior recoveries. Research by others has shown that recoveries after financial crises tend to be sharper than other recoveries, not slower as some have suggested. It is likely that, without the repeal or substantial reform of Dodd-Frank, the U.S. economy will continue to grow only slowly into the future.

Introduction

How can we assess the effect on the economy of the Dodd-Frank Consumer Protection and Wall Street Reform Act (Dodd-Frank)? This gigantic law—clearly the most significant and costly regulation of the financial system since the New Deal—must be imposing some substantial costs, but how much and where? And are these costs balanced by commensurate benefits? Proponents claim, for example, that without Dodd-Frank we could be plunged back into a financial crisis. This is the argument advanced by Senator Elizabeth Warren, and judging by the coverage she gets in the media for these alarming statements a large number of otherwise intelligent people find these assertions credible.

Others have argued that the financial crisis was not caused by a lack of regulation but rather by the government’s housing policy, which forced a deterioration in residential mortgage underwriting standards. Lower standards built a massive housing price bubble, and when the bubble eventually collapsed the rapid decline in housing and mortgage values endangered the stability and solvency of many financial firms that held these loans. The outcome was a financial crisis in 2008 and a deep recession that ended in June 2009.1

The winners write history, and the incoming administration of Barack Obama and the Democratic supermajority in Congress blamed the crisis on insufficient regulation of the private financial sector. This narrative, although factually unsupported, gave rise to the Dodd-Frank Act, which imposed significant new regulation on the US financial system but did virtually nothing to reform the government policies that gave rise to the financial crisis.

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