The Act
President Obama assented to the Dodd-Frank Wall Street Reform and Consumer Protection Act (simply referred to as the Dodd-Frank Act) to make it a federal law on July 21, 2010 (White House, n.d). The Dodd-Frank Act was realized after more than a year of work to change the financial supervision following the immediate global financial crisis of 2008. The comprehensive Act affects more than banks and other financial institutions (Barth & Jahera, 2010). It also significantly affects other entities doing business in the US. The Act is seen as Congress’ effort to provide a solid foundation for long-standing fiscal stability in the country. It is noted that regulators are working to ensure that all provisions of the Act, which are over 240, are effectively implemented by agencies. The Act consists of 2,300 pages, which cover the latest laws for the financial sector. While the Act is not complete until all 70 studies are concluded, it still offers the most robust roadmap to shape the future of financial regulations and practices in the US, which will ultimately affect all businesses. This research paper analyzes the main topics covered in the Act. It covers the history of the Dodd-Frank Act, its implementation, impacts on business and society, and policy analysis with recommendations.
History of the Act
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub.L. 111–203, H.R. 4173; generally stated as the Dodd-Frank Act or the Wall Street Reform) was assented into federal law by President Obama on July 21, 2010, as previously mentioned. The Act was enacted as a response to the fiscal crisis of 2008, referred to as the Great Recession. It brought about vital transformation to financial regulations in the US since the first regulation was implemented after the Great Depression. The Act transformed the American financial regulatory practices that accounted for every federal financial regulatory body and nearly all aspects of the US financial services industry.
In June 2009, the Obama administration suggested this federal law when various proposed bills originated from the White House to Congress. In July 2009, the House received a description of the proposed bills, and on December 2, 2009, the House of Representatives received a new version of the proposed bill tabled by then the Financial Service Committee Chairman, Barney Frank and the former Chairman of the Senate Banking Committee, Chris Dodd. The bill acquired its name from these lawmakers because of their involvement in all its processes, and the Congress voted to name it after them.
As with any other significant reforms, critics have always participated in such processes to assess merits and limitations of the Act. In this case, some critics argued that the Act went too far and excessively regulated the financial services industry while others asserted that it is not enough to prevent another financial crisis or more bailouts.
The Wall Street Reform was necessary for the US. In the year 2008, a financial crisis not witnessed by many generations since the Great Depression had devastating effects throughout the globe, but mainly in the US. It left many Americans jobless and caused a massive loss of wealth running into trillions of dollars. Notably, the White House observed that the US broken financial regulatory system was a major factor that contributed to the Great Recession (White House, n.d). The system was fragmented, outmoded and provided an opportunity for most financial institutions to run with minimal or no oversight altogether. In addition, the system provided an opportunity for some reckless financial institutions, specifically lenders, to apply hidden fees and fine print to exploit their clients.
President Obama intervened to ensure that no such crisis ever occurs again. Consequently, the President signed the Dodd-Frank Act into law. Today, it is argued that Dodd-Frank Act is the most extensive reform that the Wall Street has ever witnessed in history. The Act is simply formulated to prevent extreme risk-taking tendencies that caused the crisis. In addition, the Act also offers rational protection for customers and families by creating new consumer protection ombudsman to stop mortgage firms and payday lenders from customer exploitation. It is expected that the new rules will provide Americans with a sound, more stable and reliable financial system to ensure a viable strong foundation for positive economic development and employment.
The Dodd-Frank Act strives to hold Wall Street accountable as a public policy prescription. The global financial crisis that led to the Act was a major failure from the business (market failure) to the government (government failure). That is, both the government and businesses did fail in their mandates. Reckless risk-taking tendencies by some Wall Street investors showed that they did not comprehend inherent risks in their decisions. Still, the government did not have sufficient rules and regulations to control and monitor activities of financial institutions appropriately, specifically the ones that were deemed ‘too big to fail’. Hence, when the crisis finally hit, the government and financial institutions lacked the means to close their operations without severe impacts on millions of American taxpayers and put the entire financial system at risk. The reforms contained in the Act are expected to control irresponsible, excessive risk-taking and ensure that Wall Street is responsible for its action.
To this end, the financial system was seen as unfair and abusive to customers. Prior to the crisis, the US had seven various regulatory bodies to monitor consumer financial services in the market. In this regard, it was established that financial institutions were not accountable because of diffused and fragmented requirements. Furthermore, most mortgage players were simply almost entirely unregulated. That is, they used outdated regulations to exploit millions of American families because the system could not adequately control the financial services industry characterized by aggressive payday lenders, mortgage lenders, credit card firms, and others who were willing to exploit the consumer. President Obama had to overcome strong lobbying from the largest financial institutions that only wanted to protect their interests. As such, the Act guaranteed stronger consumer protection ever. The Act led to the establishment of independent agencies to implement and enforce reliable sets of laws for the market. The Consumer Financial Protection Bureau (CFPB) was established to set well-defined regulations for the financial services industry, and to ensure that companies are responsible and reflect best practices in their operations. The agency oversees banks, credit unions, and other financial firms. It is also responsible for enforcing federal consumer financial regulations.
Implementation of the Act
The Dodd-Frank Act implements provisions that, among other requirements, impact the oversight and regulation of the financial system in the US. The Act offers a new resolution process for ‘too big to fail financial firms, establishes new agencies solely for executing and enforcing compliance with the new laws on consumer protections and introduces more strict rules on capital requirements. Further, the Act provides new vital changes for regulating derivatives, reforming practices of credit rating agencies, and implementing new rules for corporate governance and executive pay and compensation requirements (Morrison & Foerster, n.d). In addition, the Dodd-Frank Act has integrated the Volcker Rule to ensure registration of advisers to some private funds and introduce robust rules in the securitization market. Considering these provisions, all financial institutions are expected to understand the Act and operate within these new regulations.
The Act provides financial stability reforms by introducing various agencies, such as the Financial Stability Oversight Council (Council) and Orderly Liquidation Authority to oversee financial stability of financial institutions deemed too big to fail whose failure could destroy the economy (Lamoreaux, 2010). Another provision for liquidation or restructuring through the Orderly Liquidation Fund offers funds to help in processes of dissolving financial firms placed under receivership. In this regard, taxpayers will not be required to fund such activities. The Council is mandated to break up any financial institutions that are seen as too big to present a systemic risk to consumers. The Council can also compel such institutions to increase their capital reserve limits. Likewise, the newly created Federal Insurance Office will locate and monitor all insurance firms regarded as too big to fail.
The Consumer Financial Protection Bureau (CFPB) has been created to stop any predatory mortgage lending. Specifically, this Bureau will ensure that practices that led to the widespread lending in the subprime mortgage market are eliminated to address the origin of the crisis. It also ensures that rules of engagement are simple and clear before any purchasing decisions can be made. In addition, the Bureau ensures that mortgage dealers do not get paid excessively greater commissions from facilities designed with too much interest rates and/or fees (Morrison & Foerster, n.d). Further, the Bureau does not allow any mortgage originator to lead the customer on to sign a loan that would ultimately result in higher interests or compensations for the originator.
The Bureau is responsible for monitoring various forms of consumer lending to protect consumers (Morrison & Foerster, n.d). No lender is allowed to include automobile lenders. Further, all information must be in simple language for the public to read and comprehend, for instance, any loan application form is a perfect example for customers (Morrison & Foerster, n.d).
Another major provision is the Volcker Rule, which limits banking activities on investments, speculative tendencies on trading and has abolished proprietary trading (Coates, 2013). In this regard, the Volcker Rule has managed to distinguish commercial and investment engagements of financial institutions. Consequently, it strongly restricts a bank’s capability to use risk-on trading approaches and methods when also offering services to customers as a depository. Banks will no longer associate with hedge funds or private equity companies because such institutions are seen as extremely risky. Further, the provision also focuses on eliminating or lessening potential conflict of interests by ensuring that no financial companies trade proprietarily without adequate ‘skin in the game’ or risk retention in the market. One must recognize that the Volcker Rule has similarities with the Glass-Steagall Act that was once introduced in 1933 to prevent inherent risks associated with commercial and investment banking services delivered by financial institutions simultaneously.
The Dodd-Frank Act also introduces regulations for derivatives (Evanoff & Moeller, 2012). Specifically, it focuses on credit default swaps that were identified as major contributors to the fiscal crisis of the year 2008. The credit default swaps were mainly traded over the counter rather than the normal stock markets. Consequently, not many consumers were aware of their fundamental factors, such as the market size and potential risks they presented to the entire economy. Today, the Act has introduced an integrated trading system for trading swaps to lessen chances of nonpayment by other traders and improve higher levels of transparency through the revelation of related data and other relevant materials to consumers (Morrison & Foerster, n.d). The Volcker Rule also oversees financial companies’ services that involve derivatives in efforts to avert such big firms from engaging in large risks that may harm the entire economy.
The new law also created the SEC Office of Credit Ratings. Previously, credit rating agencies were identified as sources of fabricated, deceptive information, specifically advantageous ratings that later played a part in the Great Recession. This Office ensures that credit rating agencies improve data accuracy and provide dependable, meaningful information for all stakeholders interested in their services.
The Sarbanes-Oxley Act (SOX) received a major boost from Dodd-Frank Act to assist whistle-blowers. The Act specifically introduced a compulsory compensation program that ensures that a whistle-blower can get between 10% and 30% of the proceeds obtained from litigation settlements. It has also expanded the scope of covered employees by accounting for company workers, affiliates, and employees based in subsidiaries. Further, the Act has increased the statute of limitations up to 180 days to allow whistle-blowers to report claims after their discovery.
It is noteworthy that the Dodd-Frank Act is yet to be fully implemented because of far-reaching regulations. It is expected that once the studies required are completed, much more information will be analyzed and presented to the public. In addition, the process of making some regulations and creating agencies will take considerable time.
Impact on Business and Society
The Dodd-Frank was based on three critical pillars, which one must evaluate to understand its impacts on business and society. First, financial stability as the first pillar shows fundamental improvements in the US economy. According to the latest data from the US Department of the Treasury, over the past six years, the country has witnessed economic recovery and improved outcomes for businesses and households (US Department of the Treasury, 2016). Further, the rate of unemployment has dropped from 10% to less than 5%, the nominal household net worth has increased, business lending continues to grow, the GDP is more stable, the capital market is now robust, the country deficit has declined, and the banking sector is now stable. Second, transparency in the financial market has reduced risks in derivative markets, opaque and complex securitized products have reduced, and investors can now readily gain access to relevant information from sponsors of asset-backed securities. New efforts now advocate for transparent, simple processes involving credit cards, mortgage, and student loan disclosures. Finally, consumer protection aims at holding firms accountable for their actions. The CFP, for instance, has provided about $11.7 billion in restitution for 27 million customers who were affected by the recklessness of financial institutions (US Department of the Treasury, 2016). Further, consumers are now protected, especially in the mortgage, credit cards, and student loan products and services. The ‘Know Before You Owe’ provision now protects consumers in the auto loan market.
The Dodd-Frank Act has provoked reactions from various quarters. Among lawmakers, many believe that it was grand, comprehensive reform, which was long overdue. It would avert a possible financial crisis in the future, as well as shield consumers from multiple cases of abuse that finally culminated in the crisis. Most financial institutions have thrived on risk-taking practices to drive profitability.
Regrettably, by restricting the risk-taking capabilities of financial institutions, their profitability would decline significantly. Opponents have claimed that the Act would restrict position of the US companies in the global market compared to other companies from different regions. Specifically, opponents have claimed that ensuring compliance with these rules would disproportionately burden small emerging, community banks and other smaller financial firms. Most professionals have observed that financial institutions would be safer because of capital restrictions required under the Act. However, these requirements also contribute to a more illiquid marketing condition. Inadequate liquidity can hardly hit the bond market in which not all securities are traded as mark-to-market. Moreover, bonds may take time to be bought.
Further, the Dodd-Frank Act has set the higher reserve for banks. This implies that these institutions must have relatively higher fraction of their assets in cash, which ultimately cut the amount held in marketable securities. In reality, this Act restricts the bond marketing-making opportunities for banks, which has been their conventional practice. When banks are eliminated from the scene as dealers in securities, it would be difficult to find new experienced brokers and purchasers.
Detractors have also claimed that the Act would hinder economic growth and increase costs of doing business (Coffee, 2012). If this speculation turns true, then Americans will have to contend with higher rates of unemployment, slow business growth, and lower wages. All those new agencies required under the Act will also require substantial resources to create and run. Specifically, opponents have suggested various bills and multiple amendments thwart the Wall Street Reform (Dean & Elliott, 2016). They advocate for the repeal of the Act, have mounted many legal challenges to stop some fundamental investor protection provisions, attempted to eliminate the CFPB and the FSOC, and have sought budget cuts to derail the implementation and enforcement of the Act.
Policy Analysis
The Dodd-Frank Act is considered the most comprehensive regulation in the US history since the period of the Great Depression. It will affect all parts of the US financial services industry. The Act is yet to be fully implemented, but six years after its enactment, one may get positive comments or scathing attacks depending on respondents’ viewpoints. Overall, the Act has been effective because of its approach to change in the system. For instance, the financial services industry and the overall economy are now much sound relative to the year 2008. It has strived to address the issue of being too big to fail progressively. Detractors who claimed that the Act would hurt job creation were actually wrong because the economy has been stronger and performed better compared to other global economies. Moreover, the CFPB has performed relatively well because banks have abandoned their activities that resulted in consumer exploitation. Instead, they now engage in more lending and wealth management while limiting trading activities, but some authors claim that CRAs did not offer any useful information after the implementation of the Act (Dimitrov, Palia, & Tang, 2015).
The major strength of this Act is its comprehensive approach to regulation. Previously unregulated institutions are now accountable and gaps in the system have been closed. It has enhanced corporate governance, oversight, introduced insolvency plans, and focused on robust disclosure. On the other hand, it would be expensive to create all the required agencies to implement and enforce the plan (Marks, 2011). For instance, it is observed that in the sixth year of the Act, more than $36 billion in costs have been incurred accompanied by 73 million paperwork burden hours (Batkins & Goldbeck, 2016). Further, critics maintain that the Act would be more expensive over time as agencies, such as FHFA and CFPB strive to implement and enforce too much regulation and burdensome rules (Vartanian, 2016). Meanwhile community financial institutions are expected to face difficult environments as the Act restricts their practices.
Besides, the Act does not identify a single agency to drive implementation of all regulations. Instead, it promotes shared responsibilities among agencies, which could result in conflicting and inconsistent practices and ultimately complicate the implementation, enforcement, and assessment of impacts. It, thus, becomes difficult to coordinate activities across multiple agencies due to fragmentation (Greene, 2011).
Complex processes that resulted in the enactment of the Act took many years. Today, the Act is still in the rule-making process and will continue so until all the 70 studies are completed to conclude. Moreover, it would take more than a decade before the Act can be fully implemented. Overall, drawing conclusions based on the success or failure of the Act could be misleading. The Act is expected to introduce more rules that are new. To this end, economic performance and financial services industry outcomes show that the Act has led to some positive results. Nevertheless, it would be difficult to provide recommendations on the Act. Overall, future policymakers, should develop comprehensive Acts to ensure that past crises do not recur. Effective coordination among agencies is required, as well as supports from other policymakers to ensure that such Acts are successful. Adequate resources should also be provided. After six years, there are claims that not adequate resources have been allocated to facilitate the implementation of the Act. It also recommended that Acts should not be ‘too large’ to facilitate their rapid implementations and evaluation. Once this Act is successfully implemented, it is believed that it would realize the intended impacts, such as enhancing transparency, protecting American homeowners and families, reducing financial institutions’ excessive risk-taking practices, eliminating the use of opaque instruments in the market, and creating a sound financial system to facilitate investment and economic growth.
Vartanian (2016) observes a simple fact about many new laws: their benefits and costs are usually not known either before or after implementation. That is, the laws are based on “a pass-first and evaluate-second approach” (Vartanian, 2016), which makes it difficult to understand their immediate impacts or unplanned effects. The Dodd-Frank Act is not an exception to this approach. After six years, the government has not conducted a comprehensive empirical analysis to assess achievements in financial safety and trustworthiness relative to related costs of and restrictions on providing financial services to consumers. Thus, the new law requires a thorough empirical study for future decision-making.
Appendix
Congress number: One Hundred Eleventh Congress of the United States of America
An Act: The Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub.L. 111–203, H.R. 4173; usually referred to as the Dodd-Frank Act)
Provisions
- Title I – Financial Stability
- Financial Stability Oversight Council
- Office of Financial Research
- Title II – Orderly Liquidation Authority
- FDIC liquidation
- Orderly Liquidation Fund
- Obligation limit and funding
- Orderly Liquidation Authority Panel
- Title III – Transfer of Powers to the Comptroller, the FDIC, and the Fed
- Subtitle A—Transfer of Powers and Duties
- Subtitle B—Transitional Provisions
- Subtitle C—Federal Deposit Insurance Corporation
- Subtitle D—Other Matters
- Subtitle E—Technical and Conforming Amendments
- Title IV – Regulation of Advisers to Hedge Funds and Others
- Title V – Insurance
- Subtitle A – Federal Insurance Office
- Subtitle B – State-Based Insurance Reform
- Title VI – Improvements to Regulation
- Provisions
Background
- Title VII – Wall Street Transparency and Accountability
- Subtitle A—Regulation of Over-the-Counter Swaps Markets
- Subtitle B—Regulation of Security-Based Swap Markets
- Title VIII – Payment, Clearing and Settlement Supervision
- Title IX – Investor Protections and Improvements to the Regulation of Securities
- Subtitle A – Increasing Investor Protection
- Subtitle B – Increasing Regulatory Enforcement and Remedies
- Subtitle C – Improvements to the Regulation of Credit Rating Agencies
- Subtitle D – Improvements to the Asset-Backed Securitization Process
- Subtitle E – Accountability and Executive Compensation
- Subtitle F – Improvements to the Management of the Securities and Exchange Commission
- Subtitle G – Strengthening Corporate Governance
- Subtitle H – Municipal Securities
- Subtitle I – Public Company Accounting Oversight Board, Portfolio Margining, and Other Matters
- Subtitle J – Securities and Exchange Commission Match Funding
- Title X – Bureau of Consumer Financial Protection
- Subtitle A—Bureau of Consumer Financial Protection
- Subtitle B—General Powers of the Bureau
- Subtitle C—Specific Bureau Authorities
- Subtitle D—Preservation of State Law
- Subtitle E—Enforcement Powers
- Subtitle F—Transfer of Functions and Personnel; Transitional Provisions
- Subtitle G—Regulatory Improvements
- Subtitle H—Conforming Amendments
- Title XI – Federal Reserve System Provisions
- Governance and oversight
- Standards, plans & reports, and off-balance-sheet activities
- Title XII – Improving Access to Mainstream Financial Institutions
- Title XIII – Pay It Back Act
- Title XIV – Mortgage Reform and Anti-Predatory Lending Act
- Subtitle A – Residential Mortgage Loan Organization Standards
- Subtitle B – Minimum Standards for Mortgages
- Subtitle C – High-Cost Mortgages
- Subtitle D – Office of Housing Counseling
- Subtitle E – Mortgage Servicing
- Subtitle F – Appraisal Activities
- Subtitle G – Mortgage Resolution and Modification
- Subtitle H – Miscellaneous Provisions
- Title XV – Miscellaneous Provisions
- Restriction on U.S. approval of loans issued by International Monetary Fund
- Disclosures on conflict materials in or near the Democratic Republic of the Congo
- Reporting on mine safety
- Reporting on payments by oil, gas and minerals industries for acquisition of licenses
- Study on effectiveness of inspectors general
- Study on core deposits and brokered deposits
- Title XVI – Section 1256 Contracts
References
Barth, J., & Jahera, J. (2010). US enacts sweeping financial reform legislation. Journal of Financial Economic Policy, 2(3), 192–195. Web.
Batkins, S., & Goldbeck, D. (2016). Six years after Dodd-Frank: Higher costs, uncertain benefits. American Action Forum. Web.
Coates, J. C. (2013). Cost-benefit analysis of financial regulation: Case studies and implications. Yale Law Journal, 124(4), 882-1345.
Coffee, J. C. (2012). Political economy of Dodd-Frank: Why financial reform tends to be frustrated and systemic risk perpetuated. Cornell Law Review, 97(5), 1019-1082.
Dean, N., & Elliott, B. (2016). Dodd-Frank’s state of play. Bloomberg. Web.
Dimitrov, V., Palia, D., & Tang, L. (2015). Impact of the Dodd-Frank act on credit ratings. Journal of Financial Economics, 115(3), 505-520. Web.
Evanoff, D. D., & Moeller, W. F. (2012). Dodd-Frank: Content, purpose, implementation status, and issues. Economic Perspectives, 75-84.
Greene, E. F. (2011). Dodd–Frank: A lesson in decision avoidance. Capital Markets Law Journal, 6(1), 29-79. Web.
Lamoreaux, M. G. (2010). Financial regulatory reform: What you need to know. Journal of Accountancy. Web.
Marks, L. (2011). The significance of the Dodd-Frank Act. ISACA Journal, 5, 1-3.
Morrison & Foerster. (n.d). The Dodd-Frank Act: a cheat sheet. Web.
US Department of the Treasury. (2016). Wall Street Reform: Six years later. Web.
Vartanian, T. P. (2016). The good, the bad or the ugly of the Dodd-Frank Act – Part I. Banking Daily, 106(16), 1-6.
White House. (n.d). Wall Street Reform: The Dodd-Frank Act. Web.