Goldman Sachs CEO Lloyd Blankfein testifying on Capitol Hill, April 27, 2010. According to finance professor Edward Kane, legislators focused on banks while ignoring the entrenched shortcomings of regulators. Photograph: Chip Somodevilla/Getty Images

In a paper published last year that invokes psychologist Elizabeth Kubler-Ross’s seven stages of grief, Voltaire, and Steven Colbert, the oft-quoted (New York Times, Financial Times, Wall Street Journal) Boston College finance professor Edward Kane offered a stinging critique of the Dodd-Frank Wall Street Reform and Consumer Protection Act, passed last July. The paper, “Missing Elements in U.S. Financial Reform: A Kubler-Ross Interpretation of the Inadequacy of the Dodd-Frank Act,” attracted attention in the blogosphere for being, in the words of The Deal‘s Robert Teitelman, “perhaps the most provocative and, in its sly academic way, entertaining and enlightening papers on this subject.”

Enacted in response to the financial crisis of 2007–09, Dodd-Frank imposed limits on proprietary trading (when banks trade in the markets on their own behalf); required new disclosures relating to third-party debt instruments; set more stringent capital requirements for financial firms; and introduced tighter mortgage-lending practices, among other actions. It also established new regulatory agencies, including the Financial Stability Oversight Council and the Office of Financial Research (OFR). The intent, as President Barack Obama declared when he signed the legislation, was to ensure that the “American people will never again be asked to foot the bill for Wall Street’s mistakes.”

The framers of the act rightly concluded that defective risk management triggered the crisis, according to Kane, but in appropriating blame legislators were “cycling between the stages of denial and superficial political bargaining,” to paraphrase two of Kubler-Ross’s stages of grief. “[T]he act presumes that important mistakes were made exclusively by private firms: those whose size and complexity spread the consequences of their aggressive risk-taking too widely for the private financial system and the government’s formal safety net to handle,” he writes. “This view disregards governmental mistakes made in inspecting the safety net during the buildup phase and in administering the net during the crisis.”

By failing to extend the blame to government agencies such as the Securities and Exchange Commission, Kane maintains, Dodd-Frank’s creators ignored regulatory missteps that helped foster the crisis. Such blunders included allowing new financial stratagems designed to elude government supervision—shadow banking, for example, which created unregulated financial intermediaries to facilitate credit creation. Worse, in Kane’s view, may have been regulators’ willingness to embrace expediency at the expense of taxpayers, when they assumed the massive losses at the insurance firm AIG, for example. “In . . . programs set up to rescue financial institutions,” Kane said in an interview, “it’s understood that if you don’t allow the creditors to suffer a loss, that if you let them all get away with 100 percent of their claims. . . . [t]he regulators’ task is not anywhere nearly as hard as it would be to run the claims through the equivalent of bankruptcy, even though that would be much better for taxpayers.”

For Kane, the salient facts of the current regulatory system are these: It depends on officials who are hired largely for their political connections, individuals whose decision making is compromised by those “political debts” and by the regulators’ desire to keep post-government, private-sector job opportunities alive. Furthermore, its officials “lack staffing and expertise to tackle complex financial problems.” These conditions foster regulators who are “inclined to delay decisive action in hopes conditions will heal themselves.”

Dodd-Frank does little to address such issues, and in some ways, says Kane, the law makes matters worse, offering “numerous opportunities for the regulatory community to misread its authority or otherwise miss its marks.” In particular, he cites the act’s size (2,319 pages) and complexity; the “lengthy phase-in periods” for many of the mandated changes; and vague guidelines that leave to federal regulators the “hard work of specifying and implementing crucial details of the proposed new regulatory structure.”

Kane prescribes a number of elements legislators ought to have included in the act to rectify what he terms the persistent “incentive conflicts” that impair regulators’ ability to forestall crises. He calls for more detailed mission statements and oaths of office for regulators at all levels to strengthen their sense of accountability and duty; he goes so far as to suggest the creation of a publicly funded academy—”a nonmilitary West Point”—for regulators. Kane also recommends that the newly created Office of Financial Research be empowered to challenge the methods used and the calculations reported by private firms, much as Internal Revenue Service personnel scrutinize personal and corporate tax returns.

Another change that would advance the effectiveness of Dodd-Frank, Kane says, is greater transparency in regulators’ reporting. Because taxpayers fund the safety nets that protect financial institutions, Kane maintains the American people are shareholders in those institutions. “The kinds of information stockholders get about their stake should also be supplied for taxpayers,” he said in an interview. He wants regulators to justify their risk estimates to a “Safety Net Accountability Forecast Office,” which would in turn publish “interval estimates of the aggregate value of safety-net subsidies for different industry sectors.”

There’s a temptation among regulators, says Kane, to understate the costs to taxpayers of the safety net provided by institutions such as the Federal Deposit Insurance Corporation and the Federal Reserve—and to overstate the lasting benefits of regulatory involvement. Kane proposes assigning responsibility for measuring safety net costs and effects to a “truly independent” OFR that reports directly to the public. The goal, he says, is “to make someone specifically responsible for publicly identifying, on an ongoing basis, the ways in which regulation-induced innovation might be exploiting loopholes in the current structure of regulatory authority.”

Kane believes the public learned valuable lessons from the recent financial crisis. But, he writes, the “economic models of the policymaking process do not incorporate these lessons.” Only by acknowledging their joint culpability can federal authorities prevent future meltdowns and restore the faith of taxpayers—who, for now, are left “cycling between anger and depression.”

John Mello, Jr., is a Boston-based writer.