The Dodd-Frank Wall Street Reform and Consumer Protection Act was designed to prevent another financial crisis similar to the one that occurred in 2007–2008. The act, which was named after sponsors Sen. Christopher J. Dodd (D-Conn.) and Rep. Barney Frank (D-Mass.), is made up of numerous provisions that must be fulfilled over several years as a result of its lengthy title: the Dodd-Frank Wall Street Reform and Consumer Protection Act.
- 1 How to understand the Dodd-Frank Wall Street Reform and Consumer Protection Act
- 2 The structure of the Dodd-Frank Wall Street Reform and Consumer Protection Act
- 3 Economic Growth, Regulatory Relief, and Consumer Protection Act passed by Congress
How to understand the Dodd-Frank Wall Street Reform and Consumer Protection Act
The Dodd-Frank Wall Street Reform and Consumer Protection Act, also known as the Financial Stability Improvement Act of 2010, was a huge piece of financial regulation legislation passed during the Obama administration. The Dodd-Frank Act—usually abbreviated to just the Dodd-Frank Act—established a number of new government agencies charged with monitoring the various aspects of the law and, more broadly, various components of the financial system.
The structure of the Dodd-Frank Wall Street Reform and Consumer Protection Act
Financial Stability Oversight Council
The financial system is robust enough to allow for price fluctuations, which can be beneficial or detrimental. The Financial Stability Oversight Council and the Orderly Liquidation Authority watch for signs of financial sector instability under the Dodd-Frank Act, since a failure of these firms may have a significant negative influence on the economy (companies deemed “too big to fail”).
The Orderly Liquidation Fund, established to assist with the dismantling of financial companies that have been placed in receivership and prevent tax dollars from being used to prop up such firms, can also be utilized for liquidations or restructurements.
The council has the power to break up banks that are too big to fail; it may also push them to increase their reserve requirements. In addition, the new Federal Insurance Office was created by the Obama administration in response to major financial institutions considered too big to fail.
Consumer Financial Protection Bureau
The Consumer Financial Protection Bureau (CFPB) was created under Dodd-Frank to protect consumers from predatory lending (reflecting the general perception that the subprime mortgage market was the underlying cause of the 2007–2008 crisis) and make it easier for customers to understand the terms of a loan before agreeing to them.
In order to prevent mortgage brokers from earning more money for closing loans with higher fees and/or greater interest rates, it disincentivizes them from doing so. It also restricts mortgage originators from directing potential customers to the loan that will give them the most money back.
The CFPB also regulates other sorts of consumer loans, such as credit and debit cards, and handles consumer complaints. It requires lenders to provide information in an easy-to-understand format, excluding automobile lenders.
The Volcker Rule is another important component of Dodd-Frank, which restricts how banks may invest and eliminates speculative trading. Banks are not allowed to engage in hedge funds or private equity companies, both of which are considered excessively risky. Financial businesses are forbidden from trading proprietarily without taking “skin in the game.”
The Volcker Rule is a clear move toward the Glass-Steagall Act of 1933, which first recognized the inherent dangers of combining commercial and investment banking services. The act also includes a provision for regulating derivatives, such as credit default swaps, which were widely blamed for contributing to the 2007–2008 financial crisis.
To reduce the risk of counterparty default, the Dodd-Frank Act established centralized swap trading platforms to minimize the chance of a counterparties’ collapse. To enhance transparency in those markets, the Volcker Rule restricts financial companies’ usage of derivatives in order to prevent “too big to fail” institutions from taking excessive risks that may wreak havoc on the economy as a whole.
Securities and Exchange Commission (SEC) Office of Credit Ratings
The SEC Office of Credit Ratings was created in response to the credit rating agencies’ alleged role in causing the financial crisis. The office is responsible for ensuring that credit ratings provided by agencies are meaningful and accurate.
Whistle Blower Program
The Sarbanes-Oxley Act (SOX) of 2002, under the Dodd-Frank Wall Street Reform and Consumer Protection Act, also beefed up and expanded the program for reporting corporate misconduct. It established a mandatory bounty program under which whistleblowers may collect 10% to 30% of the proceeds from a litigation settlement, extended the scope of a covered employee to include workers in a company’s subsidiaries and affiliates, and extended the statute of limitations for whistleblower claims against employers from 90 to 180 days after an infraction is discovered.
Economic Growth, Regulatory Relief, and Consumer Protection Act passed by Congress
After Donald Trump’s election as president in 2016, he promised to repeal Dodd-Frank. The Trump administration signed a new law that repealed substantial portions of Dodd-Frank in May 2018. Siding with the critics, the U.S. Congress passed the Economic Growth, Regulatory Relief, and Consumer Protection Act, which repealed key components of the Dodd-Frank Act. It was enacted by then-President Trump on May 24, 2018, and became law shortly afterward. These are some of the provisions of the new legislation, as well as certain elements where regulations were loosened up:
The new legislation lowers the asset threshold for application of prudential standards, stress test requirements, and required risk committees for small and regional banks, which was one of the most burdensome aspects of the Dodd-Frank Act.
Banks and other institutions that hold the assets of customers but do not act as lenders or traditional bankers are subject to lower capital and leverage ratios under the new legislation.
The new legislation overpowers this restriction. It also directs the Federal Housing Finance Agency (FHFA) to establish standards for Freddie Mac and Fannie Mae to consider alternative credit scoring approaches in residential mortgage loans held by a depository institution or credit union under certain circumstances.
The Volcker Rule does not apply to lenders with less than $10 billion in assets. Smaller banks are subject to less stringent reporting and capital requirements as a result of the law.
The three major credit reporting agencies are required by law to allow consumers to freeze their credit files for free as a deterrent against fraud.