Breaking Down The Dodd-Frank Act

"No law can force anybody to be responsible; it’s still incumbent on those on Wall Street to heed the lessons of this crisis in terms of how they conduct their businesses." Barack Obama

It Was A Dark And Stormy Year…

For the economy, at least. The financial crisis that came to a head in 2008 elucidated the need for some major financial reforms in this country. In June 2009, a bill was introduced to Congress proposing such changes, and 13 months later President Obama officially signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act, more commonly known as the Dodd-Frank act.

What Does The Dodd-Frank Act Do?

Dodd-Frank, named for Senator Chris Dodd and Representative Barney Frank, is the largest financial reform introduced since The Great Depression.

The act's stated purpose is "To promote the financial stability of the United States by improving accountability and transparency in the financial system, to end 'too big to fail,' to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes."

The bill's provisions are numerous and complicated however, so we're going to spell out some of the major changes here.

Establishment of the Financial Stability Oversight Council (FSOC): This regulates banks. The council looks out for signs that indicate a bank is "too big to fail." The council has the authority to break up such banks or recommend they increase their reserve requirement, thereby forcing the bank to use more of its savings. The FSOC also requires banks to have a protocol in place should they run out of money.

Establishment of the Consumer Financial Protection Bureau (CFPB): Oversees consumer lending, credit and debit cards, and the credit reporting agencies. The CFPB directly combats lending practices that led to the crisis, such as predatory mortgage lending. It also requires that any lenders, with the exception of car dealers, use clear, easy-to-read language in their loans to consumers.

Volcker Rule: Limits the amount of speculative investing by banks. Under this rule, banks are no longer allowed to own, invest, or sponsor hedge funds or private equity funds for their own profit (because they had been doing this with their customers' money). This limits banks' earning potential, but forces them to only invest on behalf of their customers. Banks had until July of this year to divest themselves of these funds.

Regulate risky derivatives: The riskiest derivatives, like credit default swaps, were largely blamed for the recession. These are now regulated by the SEC or CFTC, and forces them to be exchanged in public.

SEC Office of Credit Ratings: Leading up to the recession credit rating agencies were giving misleading information. These ratings are now overseen by the SEC to make sure consumers have accurate credit ratings.

What Does All This Mean For Me?

Quite simply, it's now harder for financial institutions to take advantage of consumers. Anybody looking to take out a loan now has clearer information available to them, allowing them to make a better informed decisions. And big banks can no longer gamble with money that doesn't belong to them. All of this means a safer environment for the average investor.

Has It Worked?

Like any other piece of legislation, there are those who claim the Dodd-Frank Act doesn't go far enough, and others who think it goes too far. Unfortunately, it will be years before the act's implications are fully understood. Until then we won't know for sure whether the act truly accomplished its goal.