DODD-FRANK

December 26, 2016


WARNING—This might be a little, if not a lot, boring to some of you maybe most of you.

O.K., with that said, what is the Dodd-Frank Wall Street Reform and Consumer Protection Act? I hear many people indicate the restrictions placed on banks, both national and regional remain THE reason for significantly tight credit since its passage in 2010.   Let’s take a look at the Act, the basics and how bankers feel it is crimping their style.

The Dodd-Frank Wall Street Reform and Consumer Protection Act is a massive piece of financial reform legislation passed by the Obama administration in 2010 as a response to the financial crisis of 2008.  There were early signs of distress relative to the impending crisis: by 2004, U.S. homeownership had peaked at seventy percent (70%); no one was interested in buying or eating more candy. Then, during the last quarter of 2005, home prices started to fall, which led to a forty percent 940%) decline in the U.S. Home Construction Index during 2006. Not only were new homes being affected, but many subprime borrowers now could not withstand the higher interest rates and they started defaulting on their loans.  This caused 2007 to start with bad news from multiple sources. Every month, one subprime lender or another was filing for bankruptcy. During February and March 2007, more than twenty-five (25) subprime lenders filed for bankruptcy, which was enough to start the tide. In April, well-known New Century Financial also filed for bankruptcy.   According to 2007 news reports, financial firms and hedge funds owned more than one trillion ($1 T) in securities backed by these now-failing subprime mortgages – enough to start a global financial tsunami if more subprime borrowers started defaulting. By June, Bear Stearns stopped redemptions in two of its hedge funds and Merrill Lynch seized $800 million in assets from two Bear Stearns hedge funds. But even this large move was only a small affair in comparison to what was to happen in the months ahead.

1.) In simple terms, Dodd-Frank is a law that places major regulations on the financial industry. It grew out of the Great Recession with the intention of preventing another collapse of a major financial institution like Lehman Brothers.

2.) One of the main goals of the Dodd-Frank act is to have banks subjected to a number of regulations along with the possibility of being broken up if any of them are determined to be “too big to fail.”

3.)  To accomplish the goal stated in item number two above, the act created the Financial Stability Oversight Council (FSOC). It looks out for risks that affect the entire financial industry. The Council is chaired by the Treasury Secretary, and has nine members including the Federal Reserve, the Securities and Exchange Commission and the new Consumer Financial Protection Bureau or CFPA. It also oversees non-bank financial firms like hedge funds. If any of the banks gets too big in the council’s determination, they could be regulated by the Federal Reserve, which can ask a bank to increase its reserve requirement—the money it has ‘saved up’ and is not using for lending or business costs.

4.) Under Dodd-Frank, banks are also required to have plans for a quick and orderly shutdown in the event that the bank becomes insolvent—or runs out of money.

5.)  The Volcker Rule is part of Dodd-Frank and prohibits banks from owning, investing, or sponsoring hedge funds, private equity funds, or any proprietary trading operations for their own profit.  The Volcker Rule does allow some trading when it’s necessary for the bank to run its business. For example, banks can engage in currency trading to offset their own holdings in a foreign currency.

There are many financial types that see real issues with Dodd-Frank.  These are as follows:

  • Codifies Too-Big-to-Fail. Rather than eliminating the market’s expectation that certain big financial firms are too big to fail, Dodd-Frank creates an explicit set of too-big-to-fail entities—those selected by the Financial Stability Oversight Council for special regulation by the Fed.
  • Threatens Small Businesses.Dodd-Frank’s complex web of regulations favors large financial firms that can afford the lawyers to analyze them. New requirements will be disproportionately costly for small banks and small credit rating agencies. Dodd-Frank’s complex derivatives rules will further concentrate an already concentrated industry. (I can attest to this fact.  My company has been trying to obtain financing for a local CNG project for over two years.  Just now getting that financing in place.  We are not asking for millions of dollars but even that has come under intense scrutiny.)
  • Hurts Retail Investors.Dodd-Frank gives the Securities and Exchange Commission a new set of responsibilities that distracts it from its core mission. New rules impose costs on nonfinancial companies that will be passed on to investors and consumers. Commission resources will be diverted to protecting the wealthiest investors.
  • Consumer “Protections” Harm Consumers. The consumer financial products regulator established by Dodd-Frank, rather than helping consumers, threatens to raise the prices consumers pay and limit the products, services, and providers available to help them achieve their financial objectives. Various rules, such as price controls on banks’ debit charge fees to merchants, are likely to increase bank fees for consumers and drive low-income customers away from basic banking services.
  • Sows the Seeds for the Next Financial Crisis. Dodd-Frank forces complex derivatives into clearinghouses. These entities will be large, difficult to manage safely, and very deeply connected with the rest of the financial markets. If one of these clearinghouses runs into trouble, the economic ramifications could be massive, which means the government will be tempted to engineer a bailout.
  • Creates New Unaccountable Bureaucracies. Dodd-Frank establishes several new bureaucracies, including consumer protection, data management, and stability oversight agencies that operate with limited transparency and little accountability to the American people.
  • More Power for Failed Regulators. Despite their past regulatory failures, Dodd-Frank gives the Securities and Exchange Commission and the Fed broad new regulatory powers.
  • Unchecked Government Power to Seize Firms. Dodd-Frank allows the government to sidestep bankruptcy and instead seize and liquidate companies. Vague criteria define which companies may be seized, and there is limited judicial oversight of the whole process. The Federal Deposit Insurance Corporation might use the process to prop up failing firms and to favor particular creditors.
  • Interferes with Basic Market Functions. The Volcker Rule, which prohibits banks from engaging in proprietary trading and limits their investments in hedge funds and other private funds, is proving to be difficult to implement. It will be more difficult to comply with and will interfere with the functioning of the market.
  • Replaces Market Monitoring with Regulatory Monitoring. Dodd-Frank relies on the hope that regulators that failed before and during the last crisis will be able to spot problems in the future. For example, Dodd-Frank gives broad new systemic risk oversight responsibilities to the Fed and the Financial Stability Oversight Council. It also raises the deposit insurance cap to $250,000, which will discourage large depositors from monitoring banks and correspondingly increase the likelihood of regulatory intervention.

If you aren’t asleep by now I can’t help you.  This is the long and short of the Dodd-Frank Act.  I would say reform was needed to reign in banks and financial firms that had grossly overstepped their mandates.  GREED was their goal.  They achieved that goal for a short period of time with consequences that have shaken our country and global finance.  Please not that now one banker, insurance company, hedge fund manager or other individual was charged with criminal activity.  Heavy fines were assigned but no one is now doing time for their misdeeds.

 

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