Dodd-Frank On The Chopping Block: Why Were Provisions Introduced And Why Are They Getting Cut?

The Dodd-Frank Act has earned the disdain of the Republicans ever since it was enacted. The collective opposition to the regulation was exemplified in President Donald Trump's statement that said the Dodd-Frank Act is a disaster. The president said he soon plans to do a "big number" on the 2010 law.

The Act And Its Origin

The Dodd-Frank Wall Street Reform and Consumer Protection Act, referred to as Dodd-Frank in short is an act signed into a law by former President Barack Obama on July 21, 2010.

This act transferred the onus of the regulation of the financial industry into the hands of the government following the financial crisis of 2007–2008, which led to the collapse of Lehman Brothers on September 15, 2008. The crisis traces back to the meltdown of the sub-prime mortgage market, which then developed into a full-blown international banking crisis following the bankruptcy of Lehman Brothers.

The housing market boom seen until early 2006 led to indiscriminate lending for home buying, and many of the high-risk mortgage loans called sub-prime loans were bundled into financial instruments called mortgage-backed securities, which passed off as low-risk securities. This semblance of low risk led to mortgage lenders, adopting loose credit standards and turning aggressive in lending. The subsequent defaulting on these mortgages led to the subprime crisis.

The Dodd-Frank Act was enacted with the objective of preventing another financial crisis through the establishment of new financial regulatory processes that would ascertain transparency and accountability, while also ensuing the protection of consumer interests.

Main Features Of The Act

The Act created the Financial Stability Oversight Council, or the FSOC, in the Treasury Department, with the Treasury Secretary as the chair of the council. The FSOC was vested with the responsibility of monitoring excessive risks to the U.S. financial system arising from the failure of large banks and non-banking companies and to eliminate the thinking that any American financial firm is too big to fail. The council was given the responsibility of resolving a failing bank without using government bailout or engendering risks to the financial system.

Another agency created by the Act is the Consumer Finance Protection Bureau that regulates retail financial products sold to consumers.

The largest of the financial institutions in the U.S. were required to undergo stress tests. The Act categorized the minimum threshold for a financial institution to be called a systematically important group is now $50 billion. Mid-sized banks having assets between $10 billion and $50 billion also came under intense scrutiny.

The Volcker Rule, named after former Federal Reserve Chairman Paul Volcker, was also included in the act. The Volcker Rule sought to ban conflict of interest trading, meaning proprietary trading. Investments of financial institutions in hedge funds and private equity firms were also curtailed.

Did The Act Hit The Bull's Eye?

Though there have been hue and cry over the act, there is no denying of the fact that it brought about a semblance of stability. A Forbes article highlighted the fact that no major investment banks were left saddled with losses from the collapse in oil prices in 2014. Even as the European debt crisis impacted many European financial institutions recently, their U.S. counterparts stood firm on the support of the capital cushion built up over the years.

Why Trump Is Looking To Overhaul The Dodd-Frank Act

Trump's team believes the act stymies financial institutions due to the myriad regulations despite the banks being highly capitalized. The FSOC, according to Gary Cohn, White House National Economic Council director, has not succeeded in building a system to resolve a failing bank without government aid or posing a risk to the financial system.

The contentious Volcker Rule is facing the displeasure of financial institutions, primarily due to the rule remaining vague in outlining the difference between proprietary trading and market making. Therefore, most financial institutions have washed their hands off market making, creating illiquidity in the markets. This aspect of the rule has also been condemned by investors. Another setback caused by the rule is the flight of investing talent from big banks to unregulated or less regulated outfits.

The Conclusion

Republican Jen Hensarling, chairman of the House Financial Services Committee, has floated around a proposal that can effectively replace the Frank-Dodd Act, with the committee having approved the legislation in September last.

According to a Wall Street Journal report, the proposal includes provisions for banks opting for an alternative regulatory apparatus if they meet certain criteria, repealing the power of the government to label a firm as systemically important, removing the power of regulators to steer a firm through bankruptcy and instead allowing them to adopt the bankruptcy code.

The financial institutions, which are the protagonists of the whole development, however, aren't in favor of a repeal of the act. JPM's James Dimon said at a financial services conference last December, "We're not asking for wholesale throwing out Dodd-Frank." Rather, they are calling for regulations to be made simpler and less costly.

This is logical, considering the huge investments banks have made to comply with the regulations. The banks had exited proprietary trading and adopted several other measures to make banking safer for customers. A complete repeal would mean undoing of all the good works and burdening them with task of compliance with a whole new set of regulations.

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Image Credit: By White House (Pete Souza) / Maison Blanche (Pete Souza) (The Official White House Photostream) [Public domain], via Wikimedia Commons