The Wall Street Reform and Consumer Protection Act of 2010
The Wall Street Reform and Consumer Protection Act of 2010
The Dodd-Frank Act was enacted into law during the Obama administration as a response to the financial crisis of 2008. It was named after its sponsors, US Senator Christopher Dodd and US Representative Barney Frank. The Dodd-Frank Bill sought to introduce significant changes to financial regulation and create new government agencies tasked with implementing the various clauses in the law. The law affected all federal regulatory bodies and almost all parts of the financial services industry.
Although the Dodd-Frank Act supposedly improved financial stability and consumer protection in the United States, critics say that it adversely affected small financial institutions and small investors. When President Donald Trump assumed office, he pledged to repeal sections of the law and on February 3, 2017, he signed an executive order directing regulators to review the Act and make suggestions on potential reforms. On June 8, 3017, the House of Representatives passed the Financial Choice Act, which aims to roll back sections of the Dodd-Frank Act.
Dodd-Frank has been roundly criticized in the financial industry on a number of grounds, but mainly on the basis that it added onerous government regulation that failed to offer any real protection for consumers or the economy. Some have charged that Dodd-Frank was just an attempt to obscure the culpability of Dodd and Frank themselves in precipitating the financial crisis by initiating government policies that pressured banks to make more subprime loans. It’s perhaps worth noting that both Chris Dodd and Barney Frank have since lost their seats in Congress.
Due to the perceived low regulation and high reliance on large banks, the Dodd-Frank Act aimed to introduce more stringent rules in banking regulation to avoid a re-occurrence of the 2008 Financial Crisis. To achieve this, the Act established the Financial Stability Oversight Council (FSOC) to address issues affecting the financial industry. The council was created alongside the Office of Financial Research under Title I of the Act. The two agencies work closely to monitor systemic risk and research the state of the economy.
The FSOC comprises ten voting members, 9 of whom are federal regulators and the remaining voting member is the Treasury Secretary who also acts as the chair to the council. The council also includes five non-voting members. It can impose stricter regulations on institutions that are viewed as “too big to fail” and likely to pose systemic risk. It is responsible for promoting market discipline, identifying threats to the financial stability of the US, and managing emerging risks that threaten the financial system.
The Office of Financial Research (OFR) works alongside the FSOC by providing necessary data on the operations of the finance industry. The OFR is authorized to obtain data from any institution in the finance industry to help in discharging its functions. It also issues guidelines to standardize how firms report data. The head of OFR is a presidential appointee, subject to the approval by the US Senate.
The Dodd-Frank law also established the Consumer Financial Protection Bureau (CFPB) to protect consumers from large unregulated financial institutions. The agency also consolidated the functions of other agencies including the Department of Housing and Urban Development, the Federal Trade Commission, and the National Credit Union Administration. The CFPB was charged with preventing risky business practices that are likely to hurt consumers. The CFPB requires lenders to disclose information to consumers in a way that is easy to read and conceptualize.
Another key provision in the Dodd-Frank Act is the Volcker rule, which prohibits banks from making high-risk speculative investments that may disadvantage the consumers. It is named after former Federal Reserve Chairman Paul Volcker who initiated it as a response to the financial crisis. According to the Volcker rule, banks are required to set up internal compliance mechanisms that are subject to supervision by regulatory agencies. The rule limits banks from owning not more than 3% of the total ownership interests in a private equity fund or hedge fund since they are considered too risky. Institutions tasked with implementing the Volcker rule include the Office of Comptroller of the Currency, Federal Reserve System Board of Governors, the United States Securities and Exchange Commission, and the Federal Deposit Insurance Corporation.
The Volcker Rule has been criticized as, in effect, making the financial markets more vulnerable to manipulation. By shutting banks out of many investing arenas, it is easier for the few large institutional traders who remain in those markets to manipulate prices.
The Dodd-Frank Act also introduced new measures to regulate risky derivatives such as Credit Default Swaps (CDS). The CDS were traded over the counter prior to the financial crisis, and they were widely blamed for contributing to the crisis. The law created centralized exchange markets for swaps trading to reduce the possibility of default among traders. It also required greater disclosure to the public on the swap trading to reduce the risks it posed to the public. Again, the act was criticized for failing to address the role of government policies in causing the financial crisis. It was political pressure on banks that led to an abundance of risky subprime mortgages – which led to the creation of credit default swaps as a means of handling the massive amount of high-risk mortgages.
The Financial Choice Act was introduced in June 2017, with the aim of making changes to the Dodd-Frank Act. The bill was submitted to the Congress following an executive order signed by President Trump in February 2017, directing regulators to review the Dodd-Frank Act and present a report on possible reforms. One of the proposed changes to the Dodd-Frank law is to reduce the powers of the Consumer Financial Protection Bureau and the United States Securities and Exchange Commission. The Act also gives the President of the United States the power to remove the directors of the CFPB and the Federal Housing Finance Agency (FHFA) that is charged with overseeing the mortgage market.
The Dodd-Frank Act was enacted with the aim of preventing a reoccurrence of the financial crisis that almost crippled the United States financial system. Proponents of the law argue that the law has made remarkable progress in regulating financial institutions, including those that were viewed as “too big to fail.” The creation of new regulatory agencies like the CFPB and the FSOC has made it possible to more closely monitor the operations of banks and protect the consumers.
However, the critics of the law insist that it will hinder the competitiveness of US financial companies vis-a-vis foreign companies. In fact, one of the unintended consequences of Dodd-Frank has been many US investors, unhappy with over-regulated US brokerage firms, being driven overseas. Critics of Dodd-Frank further argue that the regulatory measures particularly overburden small financial institutions that did not contribute to the crisis. Critics also claim that the low-interest rates resulting from the financial crisis have affected the profitability of small banks, making it nearly impossible to sustain their operations.
Whether the Dodd-Frank Act was good regulatory legislation or one of the most onerous government control grabs in history and an act that has only served to weaken the US economy remains a subject of controversy. Continue your own financial education with the help of the following resources.
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