What is the Dodd-Frank Act?

The Great Recession, which took place between 2007-2009 had a ripple effect on the economy and working Americans. It went down as one of the most severe economic crises after the Great Depression. Not only did the financial crisis lead to millions of Americans losing jobs that helped sustain their livelihoods – many lost their wealth too. The Dodd-Frank Act was a byproduct of that financial crisis.

What is The Dodd-Frank Act?

The Dodd-Frank Act, short for Dodd-Frank Wall Street Reform and Consumer Protection Act, was enacted in 2010 and signed by President Obama. It was a response to the 2008 financial crisis and aimed to prevent a future economic collapse of that magnitude.

One of the highlights of the act was that it prohibited banks from using their accounts for speculative investing, which happened to be one cause of the 2008 crisis. Additionally, the reform put consumer protections in place and established a consumer watchdog so lenders couldn’t exploit consumers through hidden fees and fine print. These measures were so important because before the 2008 crisis, the financial system had little regulation. This led to predatory lending driven by greed, especially within the housing market. People who wouldn’t typically qualify for mortgage loans were receiving them. When the bubble created by excess lending in the market burst, the financial crisis unfolded.

Key Changes That Came With The Act

Numerous regulations were set for banks with at least $50 billion in assets. Below are some of the changes that accompanied that Dodd-Frank Act.

• • The Volcker Rule : Speculative investing on the part of financial institutions was one of the catalysts of the 2008 crash. Dodd-Frank prevented banks from engaging in speculative activities. The Volcker Rule also prohibited banks from owning, investing in, or sponsoring hedge funds and private equity funds. The goal was to ensure financial institutions weren’t putting tax payers money at risk.
  • Introduction of the Consumer Financial Protection Bureau : The CFPB was established to act as a financial regulator over the markets and increase government accountability. That includes mortgages, student loans, and credit cards. Some functions of the CFPB include writing rules, supervising some finance companies, and enforcing consumer protection laws. They may be able to fine companies that engage in deceptive practices.
  • Capital and liquidity rules : Provisions were made around capital and liquidity as a risk management measurement to ensure financial institutions had enough in their reserves. In other words, a certain amount of their assets had to be held in liquid capital. The reason for this new standard was because before Dodd-Frank, some banks had hgih leverage ratios, which is why they needed such robust bailouts when the bubble busted.
  • Introduction of the FSOC : Similar to the CFPB, the Financial Stability Oversight Council is an interagency group created to help identify and monitor risks to the financial system. The group comprises heads and deputies from the Treasury Department and independent financial regulators.
  • Too big to fail: When big banks fail, it can be disastrous for the economy. The “too big to fail” provision was directed at major financial institutions. Large banks had to compose written plans or “living wills” about how they would handle bank failures without disrupting the financial system. This should help ensure taxpayers aren’t left to clean up the mess when things go left. The primary aim was to create a safe way to liquidate financial institutions when they default.
  • Regulation over derivatives: To limit risky investments, the Securities Exchange Commission and the Commodities Futures Trading Commission could regulate over-the-counter derivatives trading. More specifically, financial institutions had to use clearinghouses before they could engage in derivative trading. Clearinghouses minimize risk by making collateral deposits mandatory and ensuring the institutions are creditworthy before they can trade.

2018 Changes to The Dodd Frank Act

When Donald Trump got elected, he made significant changes to the Dodd Frank Act to loosen some of the regulations. One way he did this was by passing the Economic Growth, Regulatory Relief, and Consumer Protection Act , passed in 2018. The goal of this legislation was to ease regulations from the Dodd-Frank Act on small businesses. One of the biggest changes was that Trump rolled back the restrictions for banks with at least $50 billion in assets and increased it to $250 billion, which were only a few banks at the time. Also, banks with less than $10 billion in assets were exempt from The Volcker Rule.

Many banks argued that the regulations were limiting, while others argued loosening them would increase the risk of another crisis. More recently, some argue that the Silicon Valley Bank collapse that happened in March, 2023, was a result of Trump’s changes to the Dodd-Frank Act.