Signed into federal law by President Barak Obama in July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (commonly referred to as the Dodd-Frank Act) legislated the most sweeping regulatory reforms to the U.S. financial sector since those enacted after the Great Depression.
Despite its official name, the Dodd-Frank Act went much farther than Wall Street reform and consumer protection from predatory lending practices. In the interest of “improving accountability and transparency in the financial system,” the Act introduced 398 new regulations affecting almost every facet of the U.S. financial services industry.
Here, we will review the historical and financial context of the Dodd-Frank Act, and discuss how its provisions and implementation impact the banking industry.
A Perfect Financial Storm: “From Wall Street to Main Street”
In the larger perspective, The Dodd-Frank Act represents the federal response to the Great Recession, an 18-month global economic downturn that began in December 2007 and lasted through June 2009. Economists attribute the cause of the recession to a number of direct and indirect domestic and international factors, from government policies to oil prices.
However, most of the factors contributing to the Great Recession are related to the worldwide financial crisis of 2007 – 2008, as well as the U.S. subprime mortgage crisis of 2007 – 2009.
The U.S. Senate’s April 2011 report, “Wall Street and the Financial Crisis: Anatomy of a Financial Collapse” the Levin-Coburn Report focused on the Wall Street meltdown. The report concluded that it was a result of “…high risk, complex financial products; undisclosed conflicts of interest; and the failure of regulators, the credit rating agencies, and the market itself to rein in the excesses of Wall Street.”
Earlier the same year, the U.S. Financial Crisis Inquiry Commission (FCIC) had released the findings of its intensive, 18-month investigation into the myriad factors contributing to the crisis. In summarizing its conclusions, the FCIC described a perfect financial storm sparked by the collapse of the housing bubble:
“While the vulnerabilities tha created the potential for crisis were years in the making, it was the collapse of the housing bubble—fueled by low interest rates, easy and available credit, scant regulation, d toxic mortgages—that was the spark that ignited a string of events, which led to a full-blown crisis in the fall of 2008. Trillions of dollars in risky mortgages had become embedded throughout the financial system, as mortgage-related securities were packaged, repackaged, and sold to investors around the world. When the bubble burst, hundreds of billions of dollars in losses in mortgages and mortgage-related securities shook markets as well as financial institutions that had significant exposures to those mortgages and had borrowed heavily against them. This happened not just in the United States but around the world. The losses were magnified by derivatives such as synthetic securities.”
“No Easy Task”: Dodd-Frank Act Support and Dissent
Speaking at the signing ceremony of the Dodd-Frank Act in July 2010, President Obama with: “Passing this bill was no easy task. To get there, we had to overcome the furious lobbying of an array of powerful interest groups and a partisan minority determined to block change.”
The Obama administration had initially sent a series of proposed bills to Congress the year before, in June 2009. Upon the bill’s passage a year later, Obama noted that its final version (passed by members of both parties of Congress) contained 90% of his proposed regulatory reforms.
Besides the formidable forces opposing the Act represented by the “array of powerful interest groups and a partisan minority,” the Act clearly had its share of powerful supporters as well. Foremost among them was Senator Elizabeth Warren, (D-Mass.), a founding member of the Consumer Financial Protection Bureau established under the Act.
Implications for the Banking Industry
Notably, the Act extends the same regulatory oversight to which commercial (depository) banks have always been subject to the “shadow” banking system, such as investment banks, private equity funds and hedge funds.
Known as the Vlocker Rule (section 619 of the Act), this provision now bans all financial institutions from trading high-risk, collateralized-debt obligations (CLOs). As of January 2015, JPMorgan Chase, Wells Fargo and Citigroup held the most CLOs, according to The Wall Street Journal.
Under the Act, banks have until 2017 to comply with its regulations. Efforts by Congressional Republicans to roll back some of them – including amendments that would allow banks to trade potentially risky FDIC-insured derivatives now disallowed under the Volcker Rule – met with strong opposition by Senator Warren and Representative Maxine Waters (D-Calif.), ranking member of the House Committee on Financial Services, and have — to date — been defeated.
While intended to correct the questionable practices of larger financial enterprises such as Fannie Mae and Freddy Mac, and end “too big to fail” financial institutions, the effects of the Act on smaller banks have been arguably most onerous. Besides ending such services as free checking, many smaller banks have had to sell their interests to larger banks under the Dodd-Frank regulatory framework.
- Posted by CEIS Review
- On Tuesday July 5th, 2016
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