Skip to main content

Thoughts on the Future of Financial Services Regulation in the U.S.

Remarks to the George Mason University Law & Economics Center's Ninth Annual Financial Services Symposium (as prepared for delivery)


Thank you, Todd, for the kind introduction. And thank you to the staff of the Law and Economics Center for the invitation to speak today. I am honored to participate in an event organized by an institution recognized as having a rich and consequential intellectual tradition. I am also grateful to Chris Mufarrige for his invaluable assistance in helping prepare my remarks today.

Before I get started, my legal minders ask that I say the following: “While I am here today as a representative of the CFPB, my remarks do not constitute legal interpretation, guidance, or advice of the CFPB, and any personal opinions or views expressed are my own and may not represent the official views or position of the CFPB.”

With that housekeeping out of the way, let’s dive in. So the LEC has asked me to talk about “the future of financial services regulation in the United States.” Now, I assume I was invited to speak because of the world-renowned ability of government bureaucrats to predict the future with uncanny accuracy. Todd, I thought you knew better! In all seriousness, financial regulation generally responds to market events rather than anticipates them. And since the future is fundamentally uncertain, a point astutely made by Alex Pollock in his most recent book1, it is tough to predict the future direction of financial regulation.

That’s not to say that I could not venture a pretty good guess about what the CFPB will be doing for the next year or so. And my predictions about the activities of our sister financial regulatory agencies and the prospects for legislation in Congress might also be serviceable, but these predictions would have a short half-life, so their accuracy would undoubtedly degrade over the long-term.

Now, having heard my proverbial punt on today’s topic, before you all get up and walk out the door, I ask your indulgence to revise my charge to discuss not where financial services regulation will be going, but instead where I think it should be going.

I gather that most of your program has been about the application of new technologies in the financial services industry. This focus is appropriate and timely. In my view, the business of banking, as well as other financial services, is fundamentally about relationships between people. Call it relationship banking, or just plain customer service. Competitive enterprises have to treat their customers well or pay the price, and their need to satisfy customer demand drives technological innovation. New technologies have always influenced and shaped financial products and services, and they will continue to alter the relationship between customers and their financial service providers.

In that sense, the perennial challenge of regulation will still exist. Change is coming, but that change is uncertain, and legislators have seen fit to delegate their authority to regulators to make sometimes-difficult decisions in the midst of this uncertainty. Financial regulators must certainly be prepared to adapt and respond to changing circumstances. However, to have any sense of where financial regulation should be going, perhaps it is best to spend a little time thinking about where it has been going.

History of financial regulation

Here, we have a century and a half or so of history to consider going all the way back to the National Bank Acts of 1863 and 1864. We also have the Federal Reserve Act, the McFadden Act, Glass-Steagall, and the Banking Act of 1935, among other developments. Collectively, they established our basis for currency, branching, deposit insurance, and safety and soundness requirements. And looking to more recent history, we have the Basel Committee capital framework, concentration limits, capital distribution, source of strength doctrine, prop trading and affiliate transaction requirements, the capital conservation buffer, capital plan submissions, CCAR, enhanced prudential standards, supervisory stress tests, the Liquidity Coverage Ratio, the Net Stable Funding Ratio, Orderly Liquidation Authority and living wills, among other developments. Although it is difficult to summarize the purpose of all of these developments succinctly, each exhibits some greater or lesser desire to promote the stability of the financial system and broader economy. Thus, the animating principle of financial services regulation seems to be financial stability.

Now, what are we to make of the outcome of this overarching objective? Has financial regulation conquered the business cycle? History has shown that this is not the case.2

In 54 of the 100 years comprising the 20th Century, one or more nations experienced a new banking crisis.3 In total, 263 such crises occurred. Now, you might assume that if financial regulators during that time intended financial regulation to achieve financial stability, and if those regulators learned from past crises, resulting regulation would make banking crises increasingly rare over time. However, the data do not bear this out. Aside from the 1940s and 1950s as countries recovered from the Second World War, crises appear to have recurred throughout the 20th Century with no decline. And no one needs reminding that we have already in this century experienced the great recession of 2007-2009 and the European sovereign debt crisis.

Now, following any financial crisis, it is natural for governments to ask a couple of questions. One is “how did this happen?” And another is “how can our law and regulations respond to prevent this from ever happening again?”

And again, if history is a guide, the standard response to these questions is some sort of inquiry into the causes of the crisis, and a response that includes some combination of more regulators and more regulations. Take the Great Recession. The response included massive bailouts of financial institutions, a Financial Crisis Inquiry Commission report, and the enactment of the Dodd-Frank Act, which made sweeping changes to our financial regulatory structure and created three new federal entities, the FSOC, OFR, and CFPB.

So, in the big picture, the answer to the question of where has financial regulation been going comes in to focus: generally speaking, frequent crises continue unabated, and the government continues to respond by layering new regulations on top of old in the pursuit of financial stability. Now, I readily concede that there appears to be a logic to these developments.

Complex versus complicated systems

However, there is a blind spot in this calculation, which is that if the purpose of our regulatory regime is financial stability and if repeated financial crises manifest instability, then why do we keep getting it wrong? Surely, our best response cannot be more of the same.

I would submit that one of the major reasons regulators keep “getting it wrong,” so to speak, is that they keep making a categorical error in their approach to regulation. Let me take a minute to explain my meaning. Think about the following two words: complicated and complex. Do you think of these words as synonyms? Or do you assign them different definitions? In common usage, they are interchangeable. But in systems theory, they are profoundly different, and I think understanding this difference should help shape the direction of where we are going with financial regulation.

Consider two examples of what I mean. The first is a space shuttle. What is a space shuttle? It is a sophisticated machine intended to take man into space and return him safely to Earth. There are a couple of million moving parts to a space shuttle4, each finely engineered to demanding tolerances. But when assembled in the correct pattern, they respond to human input in a predictable way. Manipulate its control surfaces, and its glide pattern in descent will respond accordingly. This is an example of a complicated system. The whole is the sum of its parts.

Now consider instead a second example of an equities market. How do we describe this type of system? It consists of millions of independent economic actors, each responding in real time to price movements and other information, as well as the behavior of competing actors. We say that is a complex system, and even more than that, it is adaptive. A complex adaptive system exhibits emergent orders, where, unlike the space shuttle, the whole is more than the sum of its parts.5 Complex adaptive systems also have other attributes. For example, independent actors operating within the system self-organize into patterns. Or, where small changes in initial conditions produce large chaotic changes later.6 And finally, complex adaptive systems are characterized by adaptive interaction, where different actors with bounded rationality interact with others, and as experience accumulates, modify their strategies in diverse ways.7

If some of this material appears to some of you as old wine in new bottles that is because F.A. Hayek explored many of these ideas. Indeed, during the Economic Calculation debate command-and-control economists focused on static, equilibrium efficiency concerns and advocated for central planning—that is, they sought to manage the economy as if it were a complicated system. Hayek reoriented the debate to focus on what happens when there are disruptions or changes in the market. He explained how a command-and-control institution of bureaucratic planning fails to adapt to such changes. And Hayek demonstrated conclusively that without the market process, it is impossible for the adaptive process to operate.

Hayek noted in particular that a central planning board would be slower to respond to local changes and eventual responses to such changes would be less refined than market responses. As Hayek put it, the central planning board would be immune to “the particular circumstances of time and place.”8 And because of the very same practical limits to knowledge gathering, the central board would be unable to adapt to ongoing needs and changes in preferences, and ultimately would fail to represent the opportunity cost in final production decisions fully. As Hayek so presciently pointed out, complicated systems and complex adaptive systems present entirely different management challenges.

A better way forward

Complicated systems are usually designed to achieve a specific end, like solving a problem. And those problems need not be simple to solve; indeed, they can be can be very difficult. Think of the difficulty of putting man on the moon and returning him safely to Earth. But if you design and apply the right rule, you can achieve your desired result.9 Problems can also be resolved with hierarchical command and control structures and processes,10 like how an army transmits orders in prosecuting a battle.

However, you would make a big mistake if you tried to manage a complex adaptive system like a complicated system. For one thing, there are too many unknowns and interrelated, adaptive actors to govern with rigid, command-and-control rules and processes. You cannot rely upon the same input to produce the same output. For another thing, you cannot really “solve” an identified problem because the system itself does not serve a designed purpose. Markets, for example, are the result of spontaneous order rather than deliberate design. Those attempting to manage a complex adaptive system must accept the uncertainty and ambiguity inherent in its spontaneous and emergent behavior, and accept the reality that markets do not serve a specific end or policy goal.11

The modern regulatory paradigm generally views financial systems as too large and complicated to rely on market ordering. This partly explains why we see tens of thousands of pages worth of regulation in the Federal Register. But is it true that large and complex systems cannot or should not rely on market ordering and market-reinforcing rules to govern financial activities?12

It is an uncontroversial observation that large and complex natural systems like a human body or an ecosystem self-regulate. That is, these systems have inherent qualities that allow them to adapt and evolve in response to exogenous or endogenous changes. There is no central authority dictating these adaptive responses. Yet whenever one attempts to analogize this uncontroversial observation to human institutions,13 one is usually met with skepticism. For example, many believe that as a system becomes larger and more complex, the rules that govern activity within the system must be commensurately large and complex. Though there have been explicit criticisms offered against this belief,14 it is clearly the orthodoxy that has governed the American regulatory environment.

Now, if you accept my distinction between complicated and complex systems, and my conclusion that the two systems cannot be managed the same way, perhaps I can persuade you that one of the reasons financial regulators keep “getting it wrong,” so to speak, is that they keep trying to apply command-and control rules to complex, adaptive markets in an attempt to solve the problem of market instability.

Market-reinforcing versus market-replacing regulation

One example that comes to mind is the Basel Committee’s risk-based capital rules.15 The idea seems to be that if a complicated formula that assigns individual risk weights to all manner of asset types is applied to bank balance sheets, the banks can be made safer and financial stability can be improved. This approach might work if our financial system were a complicated system. But it is not. And where the regulators inevitably assign incorrect risk weights to particular asset classes, like mortgage backed securities, for instance, they create perverse incentives for market participants to hold more or less of those assets than those participants might under natural market conditions. And the risks associated with these incentives accumulate over time until they manifest in unpredictable and potentially damaging ways. Yet the response to the limitations of the Basel regime so far has been successive iterations of the same basic idea, but with each version more complicated than the one that came before it.

Other examples of this same fundamental misapplication of complicated rules to a complex system are legion within the financial regulatory arena. But identifying them is only the start of determining where financial regulation should not go. We have only explored why regulators tend to make certain categorical regulatory errors; we have not yet explored what lessons this can yield, and how this can help us regulate complex adaptive systems like financial markets.

On this score, I have a few thoughts. First, I would like to make clear that I am not suggesting that we should not have financial regulations. To the contrary, last fall at a national meeting of consumer advocates, I expressly acknowledged the utility of market-reinforcing regulation.16 I want to recapitulate the main points of that discussion briefly. In my remarks, I argued that the CFPB’s guiding regulatory principle should be animated by a concept I defined as a presumption in favor of consumer choice.

Because markets cannot operate effectively without allowing individuals to shape their lives in the manner they see best, government should respect consumer sovereignty. It should not attempt to replace the consumer’s preferences with its own preferences. That is to say, the legitimate role for government intervention is limited to market-reinforcing, not market-replacing, rules.17

Now, why do I think that the CFPB should focus on reinforcing market activity? Well, because we have a tremendous amount of evidence demonstrating that markets improve the lives of all people, most importantly the least-well-off among us. In some parts of the world, including the United States, average income has risen from 3 dollars a day (in present day prices) two centuries ago to over 130 dollars a day today, a 4,000 percent increase.18

The areas of the world that have not seen similar improvements in human life have not relied on markets for as long as the United States or instead chose a command and control approach.19 Indeed, all one has to do is turn on the news today from Venezuela to see the type of damage socialist economies do to their people.

Thankfully, our country has largely avoided the missteps of so many others and primarily relied on free-markets. But a free-market system does not mean anarchy. Indeed, rules and legal obligations play a central role in a free-market system. In fact, one can think of our system as a three-legged stool.20

First, market activity is a product of competition. Firms competing over consumer dollars must offer products that offer a better value, better quality, or both. And, consumers can derive information about products through this process, especially as it relates to quality.21 Indeed, Adam Smith’s “invisible hand” of the market is itself a form of consumer protection.

Second, the general framework of contract, property, and courts of law allow market participants to coordinate and plan their lives, what is known as private ordering. This general framework allows our large and often impersonal commercial society to flourish by providing means of redress for injury. And it gives market actors who take entrepreneurial risk peace of mind courts will enforce the legal promises on which they relied.

Finally, the third leg of our stool is public agencies like the CFPB. While contract and property rights offer tremendous benefit, sometimes they are not enough to address nation-wide scams or large organizations that engage in fraudulent or deceptive practices. In the area of consumer protection, that is one of the primary reasons for the CFPB’s existence, to prevent and deter fraud and other conduct that undermines the ability of consumers to make decisions for themselves in the marketplace where neither competition nor private legal remedies adequately address the conduct.

The Bureau's 21st century approach to financial regulation

Now, some may think that financial agencies like the CFPB should engage in more prescriptive command-and-control or market-replacing regulation. Some may accept the idea that consumers cannot make the best decisions for themselves, requiring heavy-handed government intervention in the economy. But I disagree with these types of arguments22 and the notion that market-replacing rules are a better option than a general presumption in favor of consumer choice.

What the proponents of command-and-control intervention fail to appreciate is that markets are a product of human action and a decades-long evolution, not human design.23 The complexity of our markets makes it impossible for one person or a central body to control, much less fully understand.

Having made clear that market-reinforcing regulations are necessary and beneficial (and indeed, that they are the only types of regulation consistent with a free society24), let us turn to the lessons that we can learn when regulating complex adaptive markets.

One lesson is that, all else being equal, regulatory rules should be as simple as possible. Richard Epstein made this point in his book Simple Rules for a Complex World.25 Simple rules are easier for a greater proportion of actors operating within institutions to understand and adapt to, making the system more resilient overall. Simple rules also promote compliance, which has the ancillary benefit of making it easier for consumers (not to mention regulators) to distinguish between good and bad actors, thereby assisting them in making decisions and avoiding harm. Applying this lesson to our Basel framework, perhaps adopting a simple leverage ratio in place of asset risk weights would improve system resiliency.26

A related lesson is that, in addition to being simple, rules should encourage decentralized decision-making. In other words, they should err against attempts to centralize risk-management or dictate specific outcomes. Prescriptive command-and-control rules applied to complex adaptive systems tend to limit the discretion and range of motion of independent actors within the system, making it more difficult for them to adapt to changing circumstances.27

The repeated layering of these complicated rules risks ossifying the system and diminishing its resiliency.28 It also presents a challenge to regulators. How can they accurately calculate what the proper risk allocation is for an individual firm; for two firms interacting over a single product; for numerous firms interacting in the same industry; or for the financial system more generally? And how does a regulator incorporate and adapt to unintended or unforeseen consequences in response to rules governing risk?

When regulators attempt to maximize specific parameters, relating for example to centralized risk-management, or make certain products more attractive than others, they proceed as if markets are a means to produce the regulators’ ends. This is the wrong approach in my view. Financial regulators should recognize that complex market systems are not a means to accomplish their specific goals.

Another lesson is that, all else being equal, regulators should narrowly-tailor rules to address a discrete market failure. Because financial markets are complex, the more narrowly-tailored the scope of a rule, the less likely it will be to have negative unintended consequences, and the easier it will be to determine whether the rule is effective or not.

Admittedly, successfully applying these lessons will require regulators to recognize that they are capable of making mistakes, admit when they have made mistakes, and be willing to adapt quickly and try again. At the CFPB, we are attempting to apply these lessons to our work.

For instance, our Call for Evidence has helped us identify some of the unintended consequences of our past regulations and we are actively developing solutions to remedy them. Additionally, we have a statutory obligation to regularly identify and address outdated, unnecessary, or unduly burdensome regulations in order to reduce unwarranted regulatory burdens.29 Prescriptive rules ill-suited to complex markets are prime candidates for review in execution of the CFPB’s authorities in this area.

Moreover, the CFPB’s new Office of Innovation is actively developing policies that will bring the agency fully into the 21st century. For example, a serious and often overlooked problem is the regulatory uncertainty under which most firms operate. Reducing regulatory uncertainty clears the way for innovation, competition, choice, and ultimately lower prices and expanded access to credit for consumers.

Additionally, through the Office of Innovation’s proposed No Action Letter Program, the CFPB can offer firms the opportunity to expand credit while still preserving important consumer protections. Moreover, the proposed Sandbox program can also enhance regulatory coordination and facilitate innovation in highly regulated spaces by providing limited safe harbors from regulatory liability. In addition to myriad consumer benefits, these programs will also help the CFPB sooner learn about emerging technologies and potential consumer risks.

Finally, the CFPB is also dedicating substantial resources toward creating a robust cost-benefit infrastructure. The general accounting of costs and benefits has obvious import for particular rulemakings or agency action. And our efforts will not be limited to ex ante consideration of costs and benefits. Periodic retrospective analysis—analysis that investigates and tests the evidence, assumptions, and conclusions of the underlying action—is necessary for a well-functioning agency. Even where a rule has clear salutary benefits, iterative assessments offer tremendous value to the agency and the public at large. Complex systems like financial markets are constantly changing, requiring constant reappraisal and verification of the rules that govern the system.


Today’s regulatory approach suggests a “more is more” mentality. The scope and frequency of regulatory requirements continue to increase. Indeed, Dodd-Frank itself is over 800 pages. But those pages are only the tip of the iceberg—Dodd-Frank required 400 different APA rulemakings, totaling over 30,000 pages and still counting.30 And a recent Mercatus study analyzed Dodd-Frank to determine how many times it prohibits or mandates a specific activity, concluding that Dodd-Frank contains a total of over 27,000.31

And as I noted earlier, large and complicated rules and prescriptions, rather than reinforcing resilient market actors only serves to ossify salutary market activity. Some estimates have concluded that as many as 82 million labor hours have been required to comply with the new Dodd-Frank requirements.32 In addition to the explicit costs likely passed on to consumers, these requirements lull financial firms into thinking that simply keeping up with regulatory requirements is all that is required to maintain a resilient portfolio.

There are undoubtedly more lessons to learn from the application of complexity theory to the task of financial regulation. My hope is that these lessons may one day form a basis to revise our vision where financial regulation should be going – guided by the recognition that regulators cannot successfully manage complex financial markets towards an identified end, and that attempts to do so have significant adverse consequences. So instead of imposing command-and-control rules in pursuit of financial stability, we should be striving for market-reinforcing rules that promote financial resiliency and respect consumer sovereignty. That is, we should strive to promote the adaptive attributes that make complex systems like markets so beneficial to society. And if we take these lessons to heart, perhaps the future of financial services regulation in the United States will be brighter. Thank you for your time today.


  1. Alex Pollock, Finance and Philosophy: Why We're Always Surprised (2018)
  2. I allow that it is impossible to compare historical events to a counterfactual, so it must be conceded that particular events, had they occurred at all in the absence of a particular regulatory context, might have resulted in more frequent or more severe crises.
  3. Carmen M Reinhart & Kenneth S. Rogoff, This Time is Different (2009), Appendix A.4, “Historical Summaries of Banking Crises,” pp. 348-392; accord Pollock p. 54-57
  4. NASA, Space Shuttle Era Facts
  5. John H. Holland, Complexity: A Very Short Introduction 4 (2014)
  6. Id. at pg. 5.
  7. Id. 
  8. F.A. Hayek The Use of Knowledge in Society 35 AM. ECON. REV. 519 (1945).
  9. See Theodore Kinni, The Critical Difference between Complex and Complicated MIT Sloan Management Review, June 21, 2017. This is not to suggest that complicated systems cannot fail.
  10. Id.
  11. F.A. Hayek, The Nature and History of the Problem (1935), reprinting in Individualism and Economic Order (1948) at 196. (For Hayek, economic conditions generally, and the panoply of prices that emerge as a consequence of the market process “is a thing which has to be discovered, and to be discovered anew, sometimes almost from day to day, by the entrepreneur.”)
  12. See Todd J. Zywicki, Market-Reinforcing versus Market-Replacing Consumer Finance Regulation, in Reframing Financial Regulation: Enhancing Stability and Protecting Consumers (Hester Peirce and Benjamin Klutsey, eds 2016).
  13. Armen Alchian, Uncertainty, Evolution, and Economic Theory 58 J. POL. ECON. (1950).
  14. See e.g., Richard A. Epstein, SIMPLE RULES FOR A COMPLEX WORLD (1995).
  15. See also, Andrew G. Haldane, The Dog and the Frisbee (2012) (Discussing the complexity of Basel and the effect it had on regulated entities, including internal models and banking and trading books).
  16. Brian Johnson, Toward a 21st Century Approach to Consumer Protection, Remarks to Consumer Action (November 15, 2018).
  17. See Zywicki, supra note 12.
  18. Deidre N. McCloskey, How the West (and the Rest) Got Rich, Wall Street Journal, May 20th, 2016.
  19. Id. (Brazil, Russia, and South Africa…all of them fond of planning and protectionism and level playing fields—have stagnated).
  20. This analogy of a three-legged stool has been used by others to describe the role Federal agencies play in the market economy. Timothy J. Muris, The Federal Trade Commission and the Future Development of U.S. Consumer Protection Policy, Remarks before the Aspen Summit, Cyberspace and the American Dream, the Progress and Freedom Foundation (August 19th, 2003); see also Todd J. Zywicki, Bankruptcy Law as Social Legislation, 5 TEX. REV. OF L. & POL. 393, 400 (2001).
  21. See, e.g., J. Howard Beales, III et al., The Efficient Regulation of Consumer Information, 24 J. L. & ECON. 491 (1981).
  22. See Joshua D. Wright and Douglas H. Ginsburg, Behavioral Law and Economics: Its origins, Fatal Flaws, and Implications for Liberty, 106 NW. U. L. REV. 1033 (2012).
  23. See F.A. Hayek, LAW, LEGISLATION, AND LIBERTY 9 (1973) ([O]rderliness of society…was not due solely to institutions and practices which had been invented or designed for that purpose, but was largely due to a process described at first as growth and later as evolution, a process in which practices which had first been adopted for other reasons, or even purely accidentally, were preserved because they enabled the group in which they had arisen to prevail over others).
  24. Johnson, supra, note 16 (And though economic freedom alone is not sufficient for political freedom, it is unquestionably necessary).
  25. See e.g., Richard A. Epstein, SIMPLE RULES FOR A COMPLEX WORLD (1995).
  26. Haldane, supra note 15.
  27. See Todd J. Zywicki, Epstein and Polanyi on Simple Rules, Complex Systems, and Decentralization 9 CONST. POL. ECON. 143 (1995).
  28. Indeed, centralized control disincentivizes heterogeneous approaches to risk. See Philip Maymin, Why Financial Regulation is Doomed to Fail (2011) .
  29. Public L. No. 111-203 § 1021, 124 Stat. 1376, 1980 (codified at 12 U.S.C. 5511).
  30. Haldane, supra note 15; cf American Action Forum, Week in Regulation (2017) .
  31. Patrick McLaughlin, Daniel Francis,, & Oliver Sherouse, Dodd-Frank is One of the Biggest Regulatory Events Ever (2017). .
  32. American Action Forum, Regulation Rodeo (2019) .