Wall Street Reform: D.C. Has Not Won the War Yet Watching D.C. conventional wisdom change is like watching a house getting built. One day it's a pile of bricks and lumber strewn all over the ground, the next it's a completed building. There have been a lot of arguments lately that the battle to reform Wall Street has been won. Housewright Ben White of Politico does his best to turn it into an established fact with a piece last week titled "How Washington beat Wall Street," which claims that "Washington went to war against big Wall Street ... And Washington won in a blowout. In White's narrative, Wall Street has been reduced to a shell of its former glory, the result of "a strong reform bill" and the "mistake after mistake" that Wall Street made in pushing back on reform. Let's split White's argument into two parts. The first is whether the rule-writing process for Dodd-Frank went well or was a failure. Here we can be optimistic. Certainly White's point that Wall Street has been unsuccessful in repealing any part of the law, for now, is true. They waged a scorched-earth campaign against credit-card fee regulations, which failed. Efforts to pull back on derivatives have stalled in the Senate. The Consumer Financial Protection Bureau retains its original structure. Even the Volcker Rule wasn't a disaster. Not everything was successful. The courts, in particular, have been tossing grenades at rules without rhyme or reason. But Dodd-Frank remains largely intact. The second is whether this is the end of the story, and here the answer is a definitive no. There are at least four major issues in financial reform that still need to be addressed, and will determine how well we've reformed Wall Street. Enforcing the new rules All these rules do nothing if they aren't consistently enforced. There are reasons to worry. The Volcker Rule was immediately adjusted in order to prevent a small bank from taking a loss on a complicated investment. Experts disagree on the consequences of weakening that part of the rule, but the precedent is terrible. The concern over the strength of enforcement is a key part of the current record-setting bank settlements over bad conduct. These settlements look great until you understand that the banks will pay just a fraction of the headline numbers. The banks get tax deductions for their losses, and get credits for doing things they were likely to do anyway. The end result is that executives and shareholders haven't lost enough money to be properly incentivized to steer their firms in a better direction. This is why the lack of criminal charges looms large. It's not just about justice for previous wrongdoings - it's about making sure Wall Street knows there's been a regime change in enforcement as well. That's still a major question mark. Beyond the will, there's also the means. The CFTC's budget for regulators has been squeezed tight, even though they have one of the most important missions. Given the possibility of a Republican president in 2016 who will want to dismantle the entire enterprise, this issue is far from over. Curtailing "too big to fail" You can actually date when the financial industry and its allies started arguing that Dodd-Frank had solved all the relevant problems and that any additional solutions were unnecessary. In April 2013 Senators Sherrod Brown and David Vitter released a plan to dramatically increase the amount of capital banks must use to fund themselves. At this point the argument switched suddenly to the idea that Too Big To Fail is over, as the FDIC allegedly had solved it through the Orderly Liquidation Authority, and that Washington D.C. had won its battle against Wall Street. This is a remarkable argument, as the legal mechanisms involved are untested, especially with financial companies that span the globe. And the mechanism is under political assault too: Repealing this power is a part of the Ryan Budget. And, as Shelia Bair has noted, pushing for higher capital requirements makes sense even if all these parts of financial reform work well. So why the change? Because the argument that banks should fund themselves with much higher capital requirements had been gaining steam as an easy and practical way to help solve many of the big problems in the financial sector. The financial industry understood that having banks use a lot more equity was an easier sell than previous big ideas, such as breaking up the banks. As a result, they were quick to call a cease-fire on the topic, while pushing allies to argue that perhaps Dodd-Frank had already gone too far. There are many great examples of this, but I think the most telling is from Glenn Hubbard, dean of Columbia University Graduate School of Business and former chairman of the Council of Economic Advisers, who recently said that "greatly higher capital requirements can have unpleasant side effects." Hubbard would have likely been Treasury secretary or the Federal Reserve chair under a President Romney. Fixing the mortgage market The fight over the future of the housing market isn't over, either. The housing boom and bust, and its accompanying fraud, was caused by a dramatic expansion of the private mortgage-backed securities (MBS) market. There's extensive evidence on how these instruments were designed to fail outright, or had so many conflicts inherent in their structure that disaster is inevitable. And now conservatives, with bills like Congressman Jeb Hensarling's PATH Act, want to turn over our entire housing market over to this system. Liberal groups want to do the same, but with a complicated system of regulations and government-provided risk insurance. In between them are at least 26 different plans trying to figure out how to get the mortgage market running again. They'll need to do something, because the MBS market has collapsed, and it isn't clear how it can be restarted. Regulators have basically thrown their hands up at the parts of Dodd-Frank designed to try and regulate this MBS market. It's not even clear if forcing originators of MBS to assume some of the risk of issuing these financial products, one of the core solutions, will make it into the final rules; regulators consistently dodge the question. There's no sense that the financial sector has fixed any of these conflicts of their own, and more and more people are arguing that this system is unworkable and we should have a more explicitly public role in the process. Dealing with shadow banking Dodd-Frank is not, as ideologues on either side claim, alternatively a government takeover of finance or a nightmare of permanent corporatism. Dodd-Frank is a straightforward, practical reaction to serious problems that existed in our financial sector. Brooksley Born was right in the 1990s, when she chaired the Commodity Futures Trading Commission: The massive expansion of derivatives needed transparency and regulations to prevent AIG-like panics. Consumer financial protection was a mess, spread across a dozen agencies where it was always an orphan mission. There was no mechanism to wind down complicated Wall Street firms when they failed. Dodd-Frank tries to tackle all of these. But the bill largely punted on one of the key conceptual problems: What should we do about the shadow banking sector? As Marcus Stanley of Americans for Financial Reform argues, this is the financing that takes place through long credit intermediation chains that operate outside of traditional banking. This system increases access to credit, but makes it difficult to keep track of the people you are trading with, while also increasing overall financial fragility. There's no clear signs on how regulators will ultimately choose to deal with this. Indeed the Federal Reserve is dodging questions about whether it retains the ability to provide emergency lending to shadow banks. It's also unclear how the markets for short-term lending, which are prone to panics and crises, will end up.