The Dodd-Frank Act, Too Big to Fail, Regulations

The Dodd-Frank Wall Street Reform and Consumer Protection Act or the Dodd-Frank Act for short is a federal law that was passed by U.S. Congress in 2010. Passed under the Obama administration, the Dodd-Frank Act was created in response to the financial crisis of 2007-2008. As the financial crisis that occurred in 2007-2008 led many citizens of not only the U.S. but around the world to lose their jobs, life savings, and homes, the Dodd-Frank Act was enacted to both regulate the actions of the financial industries within the U.S. that had led to such a collapse, as well as provide consumers with protections that would aid in prevent any future economic collapse. As such, the Dodd-Frank Act introduced a number of standards provisions that were geared towards effectively overseeing various aspects of the U.S. financial system, including mortgage lenders, banks, and credit rating agencies.

What are the provisions of the Dodd-Frank Act?

The Dodd-Frank Act is a unique piece of legislation that implemented a number of agencies and legal mechanisms with the aim of promoting financial stability and reform. A large reason for this need for reform was in part due to the Too big to fail TBTF theory within banking and finance, which states that certain corporations and financial institutions have become so large and interconnected with the world economy that their individual failure would be disastrous to the greater economic system of the world. Subsequently, such institutions must inevitably be bailed out through government intervention, albeit at the expense of the everyday working person, as was the case with the Emergency Economic Stabilization Act of 2008, known colloquially as the bank bailout of 2008.

With all this being said, the Dodd-Frank Act set forth the following provisions for the purposes of protecting American consumers from future economic crises:

• Financial Stability- The Dodd-Frank Act established the Financial Stability Oversight Council and Orderly Liquidation Authority, with the aim of monitoring the financial stability of major financial institutions within the U.S. In keeping with the TBTF theory, as the failure of such financial institutions could have serious consequences to the large American economy, the Dodd-Frank Act also “provides for liquidations or restructurings via the Orderly Liquidation Fund, established to assist with the dismantling of financial companies that have been placed in receivership and prevent tax dollars from being used to prop up such firms. The council has the authority to break up banks that are considered so large as to pose systemic risk; it can also force them to increase their reserve requirements.”
• Consumer Financial Protection Bureau- The Dodd-Frank Act also established the Consumer Financial Protection Bureau or CFPB for short. The reason for the establishment of the CFPB was to prevent predatory mortgage lending, reflecting the widespread sentiment that practices and activities that were conducted with the U.S. subprime mortgage market played a large role in the 2007-2008 financial crisis. As such, CFPB worked to ensure that American consumers could better understand the terms of mortgages prior to agreeing to them, as well as “deter mortgage brokers from earning higher commissions for closing loans with higher fees and/or higher interest rates and requires that mortgage originators not 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.”
• The Volcker Rule- As another major component of the Dodd-Frank Act, the Volcker Rule restricts the ways in which U.S. banks can invest, and also places limitations on speculative trading. Moreover, the Volker Rule also eliminated proprietary trading, which refers to “a financial firm or commercial bank that invests for direct market gain rather than earning commission dollars by trading on behalf of clients.” Under the Volker Rule, banks are also prohibited from being “involved with hedge funds or private equity firms, which are considered too risky. In an effort to minimize possible conflicts of interest, financial firms are not allowed to trade proprietarily without sufficient “skin in the game.”
• Securities and Exchange Commission (SEC) Office of Credit Ratings- As Credit Rating Agencies within the U.S. were also accused of contributing to the 2007-2008 financial crisis by providing favorable investment ratings that were proven to be misleading, the Dodd-Frank Act also established the SEC Office of Credit Ratings for the purpose of “ensuring that agencies provide meaningful and reliable credit ratings of the businesses, municipalities, and other entities they evaluate.”

Why Did former President Donald Trump repeal the Dodd-Frank Act in 2018?

While the provisions set forth in the Dodd-Frank Act had many supporters, there were some critics who opposed the regulations set forth by the law. Such arguments hinge on the idea that regulating the U.S. financial institutions and industries in such a stringent way as was set forth by the Dodd-Frank Act could potentially harm the competitiveness of U.S. businesses and firms in regards to their foreign counterparts, particularly as it relates to smaller banks and financial institutions. Subsequently, Donald Trump and the U.S. Congress ultimately sided with the views of critics of the Dodd-Frank Act and enacted the Economic Growth, Regulatory Relief, and Consumer Protection Act in 2018. Under this new law, significant portions of the Dodd-Frank Act were rolled back, as many requirements and regulations that were imposed on financial institutions were significantly eased.

As the 2007-2008 financial crisis was the most significant and widespread financial crisis since the Great Depression of the late 1920s and early 1930s, wide-scale legislative changes were all but inevitable. These legislative changes took the form of the Dodd-Frank Act, which was passed with the purpose of preventing the financial harm that many American consumers experienced during the 2007-2008 financial crisis. As the Trump administration made the decision to repeal many of the provisions set forth by the Dodd-Frank Act, the effectiveness of the Economic Growth, Regulatory Relief, and Consumer Protection Act will have to be monitored in the future, as the factors that led to the financial crisis of 2007-2008 were many years if not decades in the making.