Dodd-Frank Wall Street Reform and Consumer Protection Act

The Dodd-Frank Wall Street Reform and Consumer Protection Act is a massive piece of financial reform legislation passed by the Obama administration in 2010 as a response to the financial crisis of 2008. Named after sponsors U.S. Senator Christopher J. Dodd and U.S. Representative Barney Frank, the act's numerous provisions, spelled out over roughly 2,300 pages, are being implemented over a period of several years and intended to decrease various risks in the U.S. financial system. The act established a number of new government agencies tasked with overseeing various components of the act and by extension various aspects of the banking system. President Donald Trump has pledged to repeal Dodd-Frank and on May 22, 2018, the House of Representatives voted to roll back significant pieces of Dodd-Frank.

The Financial Stability Oversight Council and Orderly Liquidation Authority monitors the financial stability of major firms whose failure could have a major negative impact on the economy (companies deemed "too big to fail.") It also provides for liquidations or restructurings via the Orderly Liquidation Fund, which provides money to assist with the dismantling of financial companies that have been placed in receivership and prevents tax dollars from being used to prop up such firms. The council has the authority to break up banks that are considered to be so large as to pose a systemic risk; it can also force them to increase their reserve requirements. Similarly, the new Federal Insurance Office is supposed to identify and monitor insurance companies considered "too big to fail."

The Consumer Financial Protection Bureau (CFPB) is supposed to prevent predatory mortgage lending (reflecting the widespread sentiment that the subprime mortgage market was the underlying cause of the 2008 catastrophe) and make it easier for consumers to understand the terms of a mortgage before finalizing the paperwork. It prevents mortgage brokers from earning higher commissions for closing loans with higher fees and/or higher interest rates and says that mortgage originators cannot steer potential borrowers to the loan that will result in the highest payment for the originator.

The CFPB also governs other types of consumer lending, including credit and debit cards and addresses consumer complaints. It requires lenders, excluding automobile lenders, to disclose information in a form that is easy for consumers to read and understand; an example is the simplified terms you'll find on credit card applications.

A key component of Dodd-Frank, the Volcker Rule (Title VI of the Act), restricts the ways banks can invest, limiting speculative trading and eliminating proprietary trading. Effectively separating the investment and commercial functions of a bank, the Volcker Rule strongly curtails an institution’s ability to employ risk-on trading techniques and strategies when also servicing clients as a depository. Banks are not allowed to be involved with hedge funds or private equity firms, as these kinds of businesses are considered too risky. In an effort to minimize possible conflict of interests, financial firms are not allowed to trade proprietarily without sufficient "skin in the game." The Volcker Rule is clearly a push back in the direction of the Glass-Steagall Act of 1933 – a law that first recognized the inherent dangers of financial entities extending commercial and investment banking services at the same time.

The act also contains a provision for regulating derivatives such as the credit default swaps that were widely blamed for contributing to the 2008 financial crisis. Because these exotic financial derivatives were traded over the counter, as opposed to centralized exchanges as stocks and commodities are, many were unaware of the size of their market and the risk they posed to the greater economy.

Dodd-Frank set up centralized exchanges for swaps trading to reduce the possibility of counterparty default and also required greater disclosure of swaps trading information to the public to increase transparency in those markets. The Volcker Rule also regulates financial firms' use of derivatives in an attempt to prevent "too-big-to-fail" institutions from taking large risks that might wreak havoc on the broader economy.

Dodd-Frank also established the SEC Office of Credit Ratings, since credit rating agencies were accused of giving misleadingly favorable investment ratings that contributed to the financial crisis. The office is tasked with ensuring that agencies improve their accuracy and provide meaningful and reliable credit ratings of the businesses, municipalities and other entities they evaluate.

Dodd-Frank strengthened and expanded the existing whistleblower program promulgated by the Sarbanes-Oxley Act (SOX). Specifically, the Act:

• Established a mandatory bounty program under which whistleblowers can receive from 10 to 30% of the proceeds from a litigation settlement
• Broadened the scope of a covered employee by including employees of the company as well as its subsidiaries and affiliates
• Extended the statute of limitations under which a whistleblower can bring forward a claim against his employer from 90 to 180 days after a violation is discovered

Proponents of Dodd-Frank believe the act will prevent our economy from experiencing a crisis like that of 2008 and protect consumers from many of the abuses that contributed to that crisis. Unfortunately, limiting the risks that a financial firm is able to take simultaneously decreases its profit-making ability. Detractors believe the bill could harm the competitiveness of U.S. firms relative to their foreign counterparts. In particular, the need to maintain regulatory compliance, they feel, unduly burdens community banks and smaller financial institutions — despite the fact that they played no part in the recession.

Such financial-world notables as former Treasury Secretary Larry Summers, Blackstone Group L.P. (BX) CEO Stephen Schwarzman, activist Carl Icahn and JPMorgan Chase & Co. (JPM) CEO Jamie Dimon also argue that, while each institution is undoubtedly safer due to capital constraints imposed by Dodd-Frank, these constraints make for a more illiquid market overall. The lack of liquidity can be especially potent in the bond market, where all securities are not mark-to-market and many bonds lack a constant supply of buyers and sellers.

The higher reserve requirements under Dodd-Frank mean banks must hold a higher percentage of their assets in cash, which decreases the amount they are able to hold in marketable securities. In effect, this limits the bond market-making role that banks have traditionally undertaken. With banks unable to play the part of a market maker, prospective buyers will have a harder time finding counteracting sellers, but, more importantly, prospective sellers will find it more difficult to find counteracting buyers.

Critics believe the act will ultimately hurt economic growth. If this criticism proves true, the act could affect Americans in the form of higher unemployment, lower wages and slower increases in wealth and living standards. Meanwhile, it will cost money to operate all these new agencies and enforce all these new rules — over 225 new rules across a total of 11 federal agencies, to be exact — and that money will come from taxpayers.

On May 22, 2018 U.S. House of Representatives voted 258-159 in favor of a bill that will significantly rollback provisions of the Dodd-Frank Act. The bipartisan legislation called the Economic Growth, Regulatory Relief and Consumer Protection Act became law in May 2018. Here are some of the provisions of this bill that reverse the stance of previous financial regulations:

• Small and Regional Banks: The new bill eases Dodd-Frank regulations for small and regional banks by increasing the asset threshold for application of prudential standards, stress test requirements and mandatory risk committees
• Large Custodial Banks: For institutions that had have custody of clients' assets but do not function as lenders or traditional bankers, the new bill proposes lower capital requirements and leverage ratios
• Mortgage Credit: The new bill exempts escrow requirements for residential mortgage loans held by a depository or credit union under certain conditions. The bill also directs the Federal Housing Finance Agency to set up standards for Freddie Mac and Fannie Mae to consider alternate credit scoring methods
• Small Lenders: The bill exempts lenders with assets less than $10 billion from requirements of the Volcker rule and proposes less stringent reporting and capital norms for small lenders
• Credit Bureaus: The bill proposes free credit security freezes for customers of credit bureaus like Equifax