The Financial Crisis and the Path of Reform

Abstract

In the lead-up to the financial crisis, the U.S. financial sector was overleveraged, short-funded, risky, and opaque. "Shadow banking" permitted institutions to avoid comprehensive supervision and capital requirements. Innovation outpaced the ability or willingness of private- and public-sector guardians to rein in risks. An asset bubble fed the system, until the market imploded in the fall of 2008. When the crisis hit, our society found itself illequipped to deal with the failure of leading financial firms. In the wake of the crisis, the Obama Administration proposed a set of reforms that were eventually embodied, in large part, in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. This Essay explores the Act's key reforms: the regulation of shadow banking, the creation of a consumer financial protection agency, and the development of a resolution authority to wind down failing financial firms. The Essay also analyzes the steps that must still occur domestically and internationally to lay a firm foundation for financial stability.