, more commonly known as simply, Dodd-Frank, was passed as a response to the economic recession of 2008-10. It introduced several significant changes to US financial regulation.
It was a legislative act that was over 2,300 pages long and was signed into federal law by then-US president Barack Obama on July 21, 2010. It is now under attack by the Trump administration and house Republicans.
The first shot was fired on Monday, January 30, 2017 as president Donald Trump signed an executive order for federal regulations to be rolled back. The new president pledged that he would repeal the restrictions on Wall Street from his predecessor’s era.
This has been a signal for house Republicans to commence their own assault on the Dodd-Frank Act. Certainly, they will be emboldened that their efforts at reform, which were blocked by the last administration will find a more receptive ear from president Trump.
There has been no effective reform of Fannie Mae or Freddie Mac
under the Dodd-Frank Act. Photo: Shutterstock
Why is there such strong opposition?
In the seven years since Dodd-Frank was passed into law there has been:
- No effective reform of Fannie Mae or Freddie Mac
- Many banking groups are still classified as too big to fail
- Red tape has spawned between 240 and up to 400 extra regulations
- Government and its agencies have become more intrusive and unaccountable
- Dodd-Frank has hampered credit-worthy middle income families from accessing credit
The Wall Street Journal said in 2010 that Dodd-Frank would raise uncertainty and increase inefficiency for more than a decade. Of course, the world was more complex in 2010 than even as recently as 1999, however, can the 16-fold increase in pages be fully justified?
Source: US Congress
It is unlikely that the act will be completely swept from the statute books. Rather, it will undergo a series of reforms and amendments. However, what is left will not bear much resemblance to the original act at all.
I am opposed to the Dodd-Frank motivation, which stated that the primary cause of the financial meltdown was insufficient government regulatory authority. This is incorrect, as while there was a need for certain areas – such as reckless lending to uncreditworthy parties, which had to be stopped – it cannot be argued that the federal government authority was inadequate.
In the years running up to 2007-08 the government had a wealth of authority that it failed to use. As an example, the Securities and Exchange Commission and the Federal Reserve had the authority to increase bank capital requirements and stop abusive lending practices, but did not exercise that authority.
Indeed, while everyone was making money it was just too easy to look the other way or not drill down into the detail of how the money was being made. Among the issues that needed addressing were:
- Easy money
- Unprecedented low interest rates coupled with adjustable rate mortgages (ARMs)
- Political motivation to extend home ownership to low income families, resulting in a bubble
- Fannie Mae and Freddie Mac purchased an unlimited amount of sub-prime mortgage debt
- Insufficient bank capital cf. to assets creating ludicrous leveraging of the debt-to-assets ratios
- Inadequate risk-disclosure requirements relating to the sale of collateralised debt obligations (CDOs) and structured investment vehicles (SIVs)
- Failure of rating agencies to disclose the inherent risks for these instruments
- Poor judgment and business practices by allowing risk to become excessively under-priced
- Dodd-Frank needs an overhaul as a glaring omission in its structure is the fourth point above, in that it does nothing with respect to Fannie Mae and Freddie Mac who were the most blatant culprits of the financial crisis
In 2008, the assumption was that as US federal agencies their debt was guaranteed by government. Therefore, there were no early warning signs when it was known that they held in over half of all mortgages, and almost all the subprime mortgages. There is no doubt that it was the housing bubble that was the critical reason for the collapse in the financial market in the US and around the world.
The Volcker Rule would have protected the public from the costs of a future crisis, instead Dodd-Frank adopted only a watered-down version while allowing regulatory agencies a wide remit to interpret the legislation, write the specific rules and then enforce them.
The result has been an acceleration in regulatory enactments that have become a significant cost burden to the US financial services sector and an impediment to overall growth. It has stymied innovation, something that has been the fundamental strength of a modern financial system.
There have also been unintended consequences, as in a highly competitive global industry such as financial services, unilateral action of one nation creates an advantageous opportunity for another.
Clean sweep? It's unlikely Dodd-Frank will be completely swept from the statute books.
Another Trump contradiction
It will not escape one's notice that here is the new President looking to empower Wall Street while on the campaign trail he accused the big banks of being a corrupt global structure that had a stranglehold on the world. Is it odd then that house Republicans will also be determined to repeal the provision of the Volcker Rule within Dodd-Frank, which prevents banks from making risky bets with their own money?
The administration would contend that reforming Dodd-Frank would benefit working people and that the rule puts American companies at a disadvantage. The Republican-controlled House Financial Services Committee (32 Republicans, 28 Democrats) has called it a “politically motivated mandate”.
However, we must note that each political strategy can be limited as legislation to repeal Dodd-Frank could stall in the Senate, where it needs 60 votes, even though the Congressional Review Act only requires a simple majority of lawmakers to repeal a rule – only 10 or so Dodd-Frank rules are vulnerable to this process.
No, thank you
While in favour of some reform, I am opposed to proposals by Robert Pittenger, the US Representative for North Carolina's 9th congressional district (Republican). He has declared an intention to repeal Dodd-Frank’s objective of protecting consumers from predatory financial products, practices and enacting new protections from abuses in payday lending, arbitration, debt collection, mortgage and auto lending. Believe me, auto-loans are the next potential flash point in the US financial system.
Wall Street is hoping that with new leaders at the SEC and the Commodity Futures Trading Commission, the new set of lawmakers will forge some leeway for violations of the Volcker rule and other regulations.
Let’s keep in place the rules that prevent excessive lending to the uncreditworthy and the reliance that taxpayers will always bail out a banking bust. I hope the incomplete plans and needless meddling in straightforward financial services that has seen compliance drain liquidity and demonise executive compensation is kept as unfinished business.
– Edited by Gayle Bryant
Stephen Pope is managing partner at Spotlight Ideas. Follow Stephen or post your comment below to engage with Saxo Bank's social trading platform.