The Dodd-Frank Wall Street Reform and Consumer Protection Act was a financial reform legislation that the Obama Administration and Congress passed in 2010 in response to the 2008 financial crisis. It is a law that is named after sponsors Christopher Dodd and Barney Frank. With more than 2,300 pages included with this legislation, many of the items were meant to roll out over several years to decrease the various risks that were present in the U.S. financial system.
Since 2018, President Donald Trump has issued a promise to repeal Dodd Frank, and the House of Representatives has voted to roll back significant pieces of it. As the legislation stands today, it is still considered the law of the land.
There were numerous systems that failed the U.S. and global economy in 2008 that came together to devastate the global infrastructure to inspire an almost worldwide recession. Dodd Frank creates several layers of regulations, oversight, and legal requirements that provide some insurance against such an outcome from ever happening again.
At the same time, Dodd Frank makes it a lot more expensive to do business in the United States if you are a lender. It can also restrict access to credit for people and households who do not have qualifying credit scores.
List of the Pros of Dodd Frank
1. It provides us with the Consumer Financial Protection Bureau.
The CFPB is now in place to help prevent predatory mortgage lending practices that worked to create the foundation of the 2008 financial crisis. Subprime mortgage markets are often identified as the leading cause of the catastrophe which happened more than a decade ago. This component of Dodd Frank makes it much easier for consumers to understand the terms that are in their lending product before they decided to finalize their paperwork.
This advantage also prevents mortgage brokers from earning a higher commission for closing a loan with higher fees or interest rates. Originators cannot steer a potential borrower to a loan that results in the highest payment for the issuer of the lending product.
2. There are other debt protections in place for consumer protection.
The CFPB also provides assistance with other types of consumer lending to reduce the acquisition of unintentional debt. That means credit cards, debit cards, and various consumer complaints are all handled through the processes of Dodd Frank right now. With the exception of automobile lenders, information disclosures must be given to consumers in a way that is easy for them to read and understand. This advantage is why there are now simplified terms that you can find on credit card applications today.
3. Dodd Frank includes the Volcker Rule.
Title VI of the Act is one of the critical components of Dodd Frank. It is known as the “Volcker Rule,” and it restricts the ways that banks can invest. It also limits speculative trading and eliminates proprietary trading. By separating the investment and commercial functions of banks, this advantage curtails the ability of the institution to employ high-risk trading techniques or strategies while also serving as a depository for their clients.
Under this rule, banks are no longer permitted to be involved with private equity firms or hedge funds since these are considered too risky. Dodd Frank also works to minimize possible conflicts of interest by disallowing financial firms to trade proprietarily without having enough of a presence there at the same time.
4. It regulates derivatives that contributed to the 2008 financial crisis.
Dodd Frank contains a provision within its pages that regulates derivatives such as credit default swaps. These issues were also widely blamed as being contributing factors to the financial crisis that occurred in 2008. Because these financial derivatives were traded over the counter instead of through centralized exchanges, there was a lack of awareness to the overall size and scope of the market and the danger they posed to the overall economy.
Now centralized exchanges for swaps trading reduces counterparty defaults while requiring more significant disclosures to the public. It creates more transparency in those markets to work on preventing future institutions from becoming too big to fail.
5. There is now the SEC Office of Credit Ratings.
Dodd Frank is responsible for the establishment of the Office of Credit Ratings for the SEC. This part of the legislation was put into place specifically because it is believed that credit rating agencies were giving misleadingly favorable investment ratings that were a contributing factor to the overall financial crisis. This office is tasked with ensuring every agency improves their data accuracy while offering reliable, meaningful credit ratings for the entities whom they evaluate.
6. It strengthened the whistleblower provisions that are present in U.S. law.
Another one of the advantages that Dodd Frank provide is an expansion and strengthening of the current whistleblower program that exists in the United States. It is promulgated by the Sarbanes-Oxley Act, establishing three key points that work to protect the individuals who point out illegal activities.
- It includes a mandatory bounty program which allows whistleblowers to receive up to 30% of the proceeds from a litigation settlement.
- It broadens the scope of covered employees to include affiliates and subsidiaries.
- It extends the statute of limitations under which someone can present a claim against an employer from 90 to 180 days after discovering a violation.
Over 4,200 tips were received during the 2016 fiscal year alone. A settlement with Merrill Lynch resulted in over $415 million to compensate for the misuse of customer cash. The program has paid out over $100 million to whistleblowers and prompted over $600 million in financial sanctions.
7. Consumers can gain access to free credit security freezes.
If you believe that you have become the victim of identity theft, then the new provisions that are part of Dodd Frank thanks to Economic Growth, Regulatory Relief, and Consumer Protection Act allow you to obtain a free credit security freeze from the three major credit bureaus. All you need to do is contact them directly in writing, by email, or through a contact form on their site to notify them of your wish to have this service offered. Instituting one freeze can then transition over to all of the other agencies. This advantage makes it possible to protect your finances more effectively before someone can open new accounts in your name or try to take your cash.
8. It creates the potential for alternate credit scoring methods.
Another change to Dodd Frank from the 2018 update passed by Congress is that escrow requirements for residential loans held by credit unions or depositories are now exempt under specific conditions. As part of this legislation, the Federal Housing Finance Agency was asked to set up standards for both Fannie Mae and Freddie Mac to start considering alternate credit scoring methods for consumers. This option seeks to compromise on the strict regulations set forth from the first push after the financial crisis to allow more homeowners to qualify for mortgages.
9. Dodd Frank provides consumers with a centralized complaint mechanism.
Before the implementation of Dodd Frank, there were 10 different agencies which had oversight over consumer protection issues. It was such a patchwork of policies that HUD and the National Credit Union Administration had equal weight in the game. That complexity made it difficult for consumers to know where they needed to go if a complaint became necessary.
Thanks to the creation of the CFPB, there is a unified complaint database and hotline that makes it much easier for the information to have a voice. More than 1 million complaints have been handled since the approval of this legislation.
10. Lenders can no longer authorize risky mortgages in the hopes of profit.
One of the primary causes of the financial crisis in 2008 were predatory mortgage practices. Lenders were providing loans to borrowers who they knew couldn’t afford their payments or would probably end up in trouble later on. The reforms created a series of structures that limited features like negative amoritzation or interest-only loans that could allow the principal to grow despite making on-time payments.
11. It ended the abuses of prepaid cards, payday loans, and similar products.
The high interest rates of payday loans can quickly trap consumers into a growing spiral of debt. Proposed rules that came about because of Dodd Frank required lenders to ensure that borrowers could pay back their debt within a reasonable time. Other financial products, such as prepaid cards, were targeted because of the high fees these items would charge. For consumers who do not qualify for a bank and their employer doesn’t offer a check, these fees could bite heavily into take home pay. Now you can start shopping for the best deals around with payday safeguards that limit the amount that the card issuers can take from you with each action.
12. Dodd Frank highlights the CEO pay gap compared to their workers.
Under the rules of Dodd Frank, public companies are now required to disclose the ratio of the salary package offered to the Chief Executive Officer compared to the median employee pay. This information will help investors to see where companies are spending their resources, and if the rate of pay is too high compared to the work being done. Since the 2008 financial crisis, the vast majority of the economic recovery that occurred went to the upper 1%. Now that these information disclosures were made public for the first time in 2018, there is more transparency and accountability in the public realm.
List of the Cons of Dodd Frank
1. Dodd Frank decreases the amount of profit that is possible in the economy.
Although the goal of Dodd-Frank Wall Street Reform and Consumer Protection Act is to limit the potential harm that can occur if financial markets spiral out of control as they did in 2008, the restrictions can cause some disadvantages as well. The most significant issue that this legislation presents is a reduction in the profit-making potential of the economy. It is possible that this bill can reduce the competitiveness of U.S. companies on the global market when compared to foreign counterparts due to the regulatory compliance requirements that are in place.
2. It could reduce the liquidity in the market.
Despite the fact that Dodd Frank can make institutions safer and less likely to fail due to the capital constraints imposed by the legislation, it also makes the market become illiquid. This disadvantage creates a problem for the bond market because not all of the securities are mark-to-market. Many bonds do not have a constant supply of buyers and sellers, which means less cash becomes available. This process creates fewer opportunities for individuals up and down the investment chain since everyone has more of their assets tied up in other processes, while banks are forced to take fewer investment risks simultaneously.
3. Banks are required to hold more of their assets in cash.
Under the rules of Dodd Frank, there is a higher reserve requirement in place for banks. They must keep a greater percentage of their assets in cash compared to what was permitted previously, decreasing what is available for them to hold in marketable securities. This action effectively limits the bond market-making role which these institutions have traditionally held in American society.
Since banks are no longer playing the role of being market makers, it is more challenging for potential buyers to find counteracting sellers. Dodd Frank also makes it more arduous for prospective sellers to find counteracting buyers.
4. It takes money to implement the new regulations in Dodd Frank.
Because companies are spending more money to make sure that they stay in regulatory compliance with the Dodd-Frank Wall Street Reform and Consumer Protection Act, there is less of it available in the general economy. Critics even suggest that the ongoing presence of this legislation could result in lower wages, higher unemployment, and an ongoing slowness to living and wealth standards in the country.
There is a total of 225 new rules that are in place across 11 different federal agencies that are all enforceable because of Dodd Frank. That money must come from somewhere too, which means taxpayers are going to front the costs on both sides of the equation.
5. Dodd Frank is no longer implemented with the same consistency.
Congress and President Donald Trump signed the Economic Growth, Regulatory Relief, and Consumer Protection Act into law in May 2018. The bill eases some of the regulations that were imposed by Dodd Frank immediately after the financial crisis, including a shift in the threshold of a bank’s value from $50 billion to $250 billion under which the institution is deemed to be too important to the economy to fail. This bill also removed the Volcker Rule for small banks that have less than $10 billion in total assets.
6. It did not make significant impacts on Fannie Mae or Freddie Mac.
Arguably one of the most significant mistakes that occurred with Dodd Frank was its treatment of the federal housing enterprises. Fannie Mae and Freddie Mac continue to operate largely untouched after the rollout of legislation intended to help protect consumers. The issues which helped to create the subprime lending process are still present with these companies that are now essentially controlled by the government. Some consumers can qualify for a mortgage with a credit score of just 580 through these companies, making them an even more significant player in the mortgage markets than they were before the crisis.
Because of the heavier loads created by Dodd Frank with regulations paired with the targeting of small business over larger ones, the result was one of the slowest economic recoveries after a recession since the 1960s.
A Final Thought on the Pros and Cons of Dodd Frank
The issue that we should all examine when implementing new regulations is that the enforcement of them depend on the individuals chosen to do the job. The new regulatory mechanisms that legislation like Dodd Frank creates mean that the people tasked with enforcing them can either choose to do good, or they can choose to do harm depending on their view and understanding of the existing problems.
Creating more regulations to prevent loopholes and unnecessary financial risks does help create stability in society. Even fiscal conservatives agree with the reasoning behind the need for the regulations in the first place. The problem is that a massive load of regulations will always reduce the potential for profit. When there are fewer risks, then the rewards are not as great.
The pros and cons of Dodd Frank are more of a reflection about where we want to go as a society. Should we allow individuals and households to make risky financial decisions? Do banks have the right to extend lending products to someone even though they know that a default is likely? There are always going to be financial risks to consider in any economy. How we control them will allow us to focus on either success or failure.
Blog Post Author Credentials
Natalie Regoli, Esq. is the author of this post and the editor-in-chief of our blog. She received her B.A. in Economics from the University of Washington and her Masters in Law from The University of Texas School of Law. In addition to being a seasoned writer, Natalie has almost two decades of experience as a lawyer and banker. If you would like to contact Natalie, then go here to send her a message.