As my colleague Paul Rose
and I have explored elsewhere
, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) has raised the stakes for financial regulation by requiring more than twenty federal agencies to promulgate hundreds of new rules and regulations. Not only has it kept the financial regulators busy, but it has also employed a horde of lawyers to challenge (and defend) the law and its implementing regulations. And it has kept law professors busy with great debates about, for instance, cost-benefit analysis in financial regulation (for example, see here
, and here
A new paradigm is afoot in banking regulation – and it involves a turn toward the more speculative. Previous regulatory instruments have included geographic restrictions, activity restrictions, disclosure mandates, capital requirements and risk management oversight to ensure the safety of the banking system. This article describes and contextualizes these regulatory tools and shows how and why they were formed to deal with industry change. The financial crisis of 2008 exposed the shortcomings in each of these regimes. In important ways, the Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”) departs from these past regimes, and proposes something new: call it “Regulation by Hypothetical.”
Regulation by Hypothetical refers to rules duly promulgated under appropriate statutory and regulatory mechanisms that require banks and their regulators today to make predictions about sources of crisis and weakness tomorrow. Those predictions – which, by their very definition, are conjectural and speculative, even hypothetical – then become the basis of the use of the state’s regulatory power. This Article discusses two prominent instances of regulation by hypothetical: stress tests, and living wills. It then discusses the strengths and weaknesses of such a regime, and describes how the reliance on regulation by hypothetical can exacerbate the practice of government sponsorship of private financial risk-taking. The article then provides a solution that would strengthen this regime: using financial war games to increase the predictive value of the hypothetical scenarios.
This article is a fascinating read, and I am still digesting the concept of regulation by hypothetical and Professor Baradaran’s suggestion that we incorporate financial war games into the regulatory approach to help minimize government facilitation of private risk-taking in the financial services sector.
I also wonder about whether regulation by hypothetical is limited to financial regulation, or if it is present in other regulatory contexts that attempt to minimize systemic risks. And whether the war games recommendation would have similar applicability in other contexts where the government engages in crisis management.
As Gillian Metzger
has recently detailed
, administrative law and financial regulation are fields that have largely developed independently, based on different framing principles. The financial crisis and the Dodd Frank response have presented scholars and policymakers with a great opportunity for “a sustained and reciprocal engagement that will provide room for rethinking regulatory approaches in both.” I look forward to reading more financial regulation scholarship like this provocative article, and I hope that second-generation Dodd Frank scholarship turns to apply the lessons learned from financial regulation to administrative law more generally.