The Dodd-Frank Act: What is it and how does it help you?

What is the Dodd-Frank Act?

President Barack Obama signed the Dodd-Frank Act into law in 2010. This was in response to the mortgage lending financial crisis that took place in 2007-2008.  The Dodd-Frank Act or the Dodd-Frank Wall Street Reform and Protection Act is a United States federal law that was enacted on July 21, 2010.  The law went into effect to make changes affecting federal financial regulatory agencies, financial regulation and almost every singe part of the financial services industry.  The initial proposal was introduced in the House of Representatives by Representative Barney Frank, a United States Congressman and Chris Dodd, a United States Senator.  In passing through the Dodd-Frank Act, it was mostly supported by Democrats, but three Senate Republicans voted for the bill to allow it to overcome the Senate filibuster.

What is the Purpose for the Dodd-Frank Act?

The main purpose of the Dodd-Frank Act was to enforce stricter regulations and transparency with consumers in order to prevent further financial crises. Since the financial crisis was a result of ongoing activity that was not monitored, the crash hit the economy pretty hard. Many lost their jobs and many lost their homes because they were unable to afford their mortgage payments. With stricter regulations and monitoring, Congress hoped to prevent future financial crises bailed out with taxpayers’ money.

The overall purpose of the Dodd-Frank Act was to re-organize the financial regulatory system.  This mean giving new responsibilities to the FDIC or Federal Deposit Insurance Corporation and created new agencies like the CFPB or Consumer Financial Protection Bureau whose main duty is protecting consumers against financial product abuses, such as credit cards, mortgages, etc.  The act also created the Financial Stability Oversight Council to identify threats to the financial stability of the United States and give the Federal Reserve more power to regulate important institutions.  In order to handle big company liquidation, the act also created the Orderly Liquidation Authority.

A few important provisions within the act include the Volcker Rule that restricts banks from making certain types of investments. Another important provision on the act required credit-default swaps and other transactions to be cleared through clearinghouses.

How does the Dodd-Frank Act help the consumer?

The Dodd-Frank Act was enacted with the financial consumer in mind.  Here are some big benefits that the consumer was expected to reap through the passing of the Dodd-Frank Act:

Monitors Wall Street and Big Insurance Companies

Th FSOC was established to identify firms in the entire financial industry that may become to big and turn them over to the Federal Reserve for supervision.  The FSOC chair is the Treasury secretary and it has a council of nine members including the SEC or Securities and Exchange Commission, the Fed, the CFPB, the Office of the Comptroller of the Currency, the FDIC, the Federal Housing Finance Agency or FHFA and the CFPA (Consumer Financial Protection Agency.  The Federal Insurance Office was also created to identify insurance companies specifically that create risk for the entire system, as well as gather information about the industry as a whole to report to Congress.

Strengthens role of Whistleblowers

Under Sarbanes-Oxley, the Dodd-Frank Act increased the role of whistle blower protections.

Shines a light on hedge fund trades and derivatives

The 2008 financial crisis was partly caused by the fact that hedge fund trades has become very complex and no one really understood them.  To counter this, Dodd-Frank has required all hedge funds to register with the SEC and provide data about their trades and portfolios.  By 2013, 65 banks across the world had registered their derivatives business with the US Commodity Futures Trading Commissions or CFTC.  Further, the SEC is tasked with regulating the most dangerous derivatives traded at a clearinghouse.

Remove ability for banks to gamble with your money

Paul Volcker, a Fed chair in the 1980s, instituted the Volcker Rule that bans banks from using deposits to trade for their profit.  Banks are only allowed to use hedge funds if a customer requested it.

Overseeing of Credit Cards, Loans, Mortgages and Credit Rating Agencies

The Office of Credit Rating at the SEC was created to regulate credit-rating agencies.  These agencies were apart of the crisis by essentially lying about the safety of some derivatives.  In conjunction, the CFPB rolled up many watchdog agencies and put them under the US Treasury Department to oversee payday and consumer loans, credit and debit cards, mortgage underwriting and other bank fees.

Reviewing Emergency Loans in the future

For future bailouts, the Government Accountability Office is now given the power to review Fed emergency loans.

Which element in the Dodd Frank Act did UDAP add?

First off, the term UDAAP stands for Unfair, Deceptive and Abusive Acts or Practices and was introduced in the Dodd-Frank Act to direct the Consumer Financial Protection Bureau to issue regulations designed to prevent these unfair, deceptive and abusive acts, mainly within the financial institution industry.  UDAP has typically been difficult to define and has caused a lot of frustration with the community bank environment surrounding overdraft practices.  UDAP is currently defined by the CFPB’s rulemaking authority and is enforced by them and existing bank regulators.  Overdrafts have been a hot topic within the media and has been a focus of regulatory exams since implementing the act especially surrounding the payment of overdrafts created by one-time debit card transactions.

How Did the Subprime Mortgage Crisis Happen?

Basically, people who were not in great financial shape were getting loans, even when they shouldn’t have. People whose credit backgrounds don’t meet conventional mortgage standards are able to get subprime mortgages. In short, subprime mortgages have higher interest rates because it is riskier, which means the monthly payments are higher for subprime borrowers. To accommodate, adjustable rate mortgages were offered since they have a low fixed rate for the first several years. With ARMs, the monthly payments would temporarily be much more affordable. Borrowers didn’t realize how expensive it could get once the initial period was over. Once the initial period ended and the interest rates adjusted, many were unable to afford their payments and ended up foreclosing on their properties and losing their homes.  Lenders were also accepting loan applications without going through the verification process to make sure the borrowers were qualified. These loose regulations became accepted throughout the industry so borrowers were starting to exaggerate their income on their applications.

What happened to Lehman Brothers?

The Lehman Brothers collapse is the name most synonymous with the US subprime mortgage-induced financial crisis.  In 2007, Lehman had a market capitalization of close to $60 billion, via the underwriting of more mortgage-backed securities than any other firm.  But by the first quarter of 2007, it was starting to show that something was wrong with the US housing market.  The stock plunged 77% in 2008 due to the equity markets dropping worldwide.  On September 15th 2008, Lehman declared bankruptcy.  This bankruptcy led to $46 billion of its market value being wiped out and led to the purchase of Merill Lynch by Bank of America.

Did the Dodd-Frank Act Succeed?

Everyone has different views and perspectives so I’m sure that many will both agree and disagree on whether or not the Dodd-Frank Act was a success. The biggest positive that came out of the Dodd-Frank Act was the long-overdue restructuring that now prioritized the protection of consumers. There were many factors that contributed to the subprime mortgage crisis, but it all boils down to people not following the rules to get more money.  With The Dodd-Frank Act, more eyes are on the mortgage industry and policies were created to make sure this didn’t happen again.

On May 22, 2018, Congress passed a rollback of the Dodd-Frank rules for small banks.  Further, Economic Growth, Regulatory Relief and Consumer Protection Act all eased regulations for these entities.  This means that the Fed can’t designate these banks as too big to fail are not subject to the Fed’s stress tests.

But there could be more trouble on the way.  President Trump has said that he would like to repeal the Dodd-Frank Act completely, as he believes it keeps banks from lending more money to small businesses.  In reality, the Act targets the large banks, which have grown since the 2008 financial crisis and small businesses are actually more likely to borrow from small banks vs. big banks.   While this hasn’t been repealed, Republicans continue to loosen the regulation in the United States through weakening the CFPB, causing enforcement actions to drop considerably despite a rise in consumer complaints.