Dodd-Frank Wall Street Reform Act
How Trump Weakened Dodd-Frank and Increased Your Risk
On May 22, 2018, Congress passed a rollbank of rules in the Dodd-Frank Wall Street Reform Act. It loosened rules on banks from $50 billion to $250 billion in assets. These "small banks" include American Express, Ally Financial, and Barclays. They can no longer be considered "too big to fail." They don't have to submit mortgage reports designed to reveal if they are following fair-lending rules. The smallest banks are already exempt. As a result, only the 10 biggest U.S. banks have to comply with Dodd-Frank.
The Trump administration has been advocating changes since February 3, 2017. Trump can't repeal Dodd-Frank probably completely. Hundreds of Dodd-Frank rules have been integrated into international banking agreements. But Republicans are loosening its regulations within the United States.
Trump claims Dodd-Frank keeps banks from lending more to small businesses. But the Act targets large banks. They have consolidated and grown since the 2008 financial crisis. Small businesses are more likely to borrow from small banks, not big banks. The biggest impediment to small banks is the low-interest rate climate that's prevailed since the financial crisis. It reduces their profitability.
Trump's cabinet members say that banks no longer need the extra rules and supervision. They argue that the banks have enough capital to withstand any crisis. But banks are only so well-capitalized because of Dodd-Frank.
Summary of the Act
It is the most comprehensive financial reform since the Glass-Steagall Act. Glass-Steagall regulated banks after the 1929 stock market crash. The Gramm-Leach-Bliley Act repealed it in 1999. That allowed banks to once again invest depositors' funds in unregulated derivatives. This deregulation helped cause the 2008 financial crisis.
The Dodd-Frank Act is named after the two Congressmen who created it. Senator Chris Dodd introduced it March 15, 2010. On May 20, it passed the Senate. U.S. Representative Barney Frank revised it in the House, which approved it June 30. On July 21, 2010, President Obama signed the Act into law.
Eight Ways Dodd-Frank Made Your World Safer: How Trump Is Changing That
1. Oversees Wall Street. The Financial Stability Oversight Council identifies risks that affect the entire financial industry. It also oversees financial firms other than banks, like hedge funds. It recommends that the Federal Reserve supervise any that gets too big. The Fed will ask the company to increase its reserve requirement. That prevents a firm from becoming too big to fail, like the American International Group Inc. The Chair of the FSOC is the Treasury Secretary. The council has nine members.
The Trump administration wants to prevent the Fed from supervising large firms. It wants the FSOC to stop designating companies like AIG as too big to fail. It claims the additional regulations make large companies noncompetitive on the global market.
2. Stops Banks from Gambling with Depositors' Money. The Volcker Rule bans banks from using or owning hedge funds for their own profit. It prohibits them from using their depositors' funds to trade on their own accounts. Banks can use hedge funds on behalf of their customers only. Dodd-Frank gave banks seven years to get out of the hedge fund business. They could keep any funds that are less than 3 percent of revenue. Banks lobbied hard against the rule, delaying its approval until December 2013.
It went into effect in April 2014. Banks had until July 21, 2015 to implement their compliance mechanisms.
The Trump administration is seeking to loosen those requirements. Regulators want to allow banks to use more funds in risky investments. If it is passed, the new rules will increase the systemic risk for everyone.
3. Regulates Risky Derivatives. Dodd-Frank requires that the most dangerous derivatives, like credit default swaps, be regulated. This task falls to the Securities and Exchange Commission or the Commodity Futures Trading Commission. It depends on the type of derivative. They will identify excessive risk-taking. That will bring it to policy-makers' attention before a major crisis occurs. A clearinghouse, similar to the stock exchange, must be set up. That ensures the derivative trades are transacted in public.
Dodd-Frank left it up to the regulators to determine the best way to create the clearinghouse. That led to a series of studies and international negotiations.
4. Brings Hedge Fund Trades Into the Light. When hedge funds and other financial advisers aren’t regulated, the underlying assets of derivatives are hidden. One of the causes of the 2008 financial crisis was that no one knew what was in the derivatives. This meant no one knew how to price them. That's why the Fed thought the subprime mortgage crisis would remain within the housing industry. Derivatives were one of the primary causes of the subprime mortgage crisis.
To correct that, Dodd-Frank requires all hedge funds to register with the SEC. Hedge funds must provide data about their trades and portfolios so the SEC can assess overall market risk. This gives states more power to regulate investment advisers. That's because Dodd-Frank raised the asset threshold from $30 million to $100 million. By January 2013, 65 banks around the world had registered their derivatives business with the CFTC.
5. Oversees Credit Rating Agencies. Dodd-Frank created an Office of Credit Ratings at the SEC. It regulates credit-rating agencies like Moody's and Standard & Poor's. Many blame the agencies for overrating some bundles of derivatives and mortgage-backed securities. Investors trusted these agencies and didn't realize the debt was in danger of not being repaid. The SEC can require agencies to submit their methodologies for review. It can deregister an agency that gives faulty ratings.
6. Regulates Credit Cards, Loans and Mortgages. The Consumer Financial Protection Bureau consolidated the functions of many different agencies. It oversees credit reporting agencies and credit and debit cards. It also oversees payday and consumer loans, except for auto loans from dealers. The CFPB regulates credit fees, including credit, debit, mortgage underwriting and bank fees. It protects homeowners by requiring they understand risky mortgage loans. It also requires banks to verify borrower's income, credit history, and job status.
The CFPB is under the U.S. Treasury Department.
Trump's plan would restructure the bureau as a multi-member commission. It would also allow the president to remove the bureau’s director for any cause. It would switch its funding from the Federal Reserve to Congress.
Trump has already reduced the Bureau's role. It no longer investigates finance companies.
7. Increases Supervision of Insurance Companies. Dodd-Frank created a new Federal Insurance Office under the Treasury Department. It identifies insurance companies that create a risk for the entire system, like AIG did. It also gathers information about the insurance industry. It makes sure affordable insurance is available to minorities and other underserved communities. It represents the United States on insurance policies in international affairs. Trump's executive order may relax oversight on three big insurance companies, including AIG.
The FIO works with states to streamline regulation of surplus lines insurance and reinsurance. In December 2014, it reported the impact of the global reinsurance market to Congress.
8. Reforms the Federal Reserve. Dodd-Frank gave the Government Accountability Office new powers. Even though the Fed worked with the Treasury during the financial crisis, the GAO audited the Fed's emergency loans made during the crisis. It can review future emergency loans when needed. The Treasury Department must approve any new emergency loans. That applies to single entities, like Bear Stearns or AIG. The Fed made public the names of banks that received these loans or TARP funds.
Additional Changes in Trump's Plan
The Treasury report also suggested other changes not mentioned above. It would reduce the requirement for bank stress tests from annually to every two years. These tests tell the Federal Reserve whether a bank has enough capital to survive an economic crisis.
It suggested modernizing the Community Reinvestment Act. That law requires banks to lend based on a household's income regardless of what neighborhood it is in. Before the Act, banks would "redline" entire neighborhoods as too risky. That meant they would refuse mortgages even to high-income households within that neighborhood.
The report proposes exempting banks that have enough capital from other Dodd-Frank regulations. This is meant to help small banks. (Sources: "Dodd-Frank Wall Street Reform Act," U.S. Senate. "Summary of Dodd-Frank Reform Act," Morrison & Forster.)