Loading the player...

What is the 'Dodd-Frank Wall Street Reform and Consumer Protection Act '

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. Named after sponsors U.S. Senator Christopher J. Dodd and U.S. Representative Barney Frank, the act's numerous provisions, spelled out over roughly 2,300 pages, are being implemented over a period of several years and are intended to decrease various risks in the U.S. financial system. The act established a number of new government agencies tasked with overseeing various components of the act and by extension various aspects of the banking system. President Donald Trump has pledged to repeal Dodd-Frank, and on June 8th, the House of Representatives voted to replace it with the Financial CHOICE Act, which will roll back significant pieces of Dodd-Frank. The CHOICE act, however, is not expected to pass the Senate in its entirety.

BREAKING DOWN 'Dodd-Frank Wall Street Reform and Consumer Protection Act '

The Financial Stability Oversight Council and Orderly Liquidation Authority monitors the financial stability of major firms whose failure could have a major negative impact on the economy (companies deemed "too big to fail"). It also provides for liquidations or restructurings via the Orderly Liquidation Fund, which provides money to assist with the dismantling of financial companies that have been placed in receivership, and prevents tax dollars from being used to prop up such firms. The council has the authority to break up banks that are considered to be so large as to pose a systemic risk; it can also force them to increase their reserve requirements. Similarly, the new Federal Insurance Office is supposed to identify and monitor insurance companies considered "too big to fail."

The Consumer Financial Protection Bureau (CFPB) is supposed to prevent predatory mortgage lending (reflecting the widespread sentiment that the subprime mortgage market was the underlying cause of the 2008 catastrophe) and make it easier for consumers to understand the terms of a mortgage before finalizing the paperwork. It prevents mortgage brokers from earning higher commissions for closing loans with higher fees and/or higher interest rates, and says that mortgage originators cannot steer potential borrowers to the loan that will result in the highest payment for the originator.

The CFPB also governs other types of consumer lending, including credit and debit cards, and addresses consumer complaints. It requires lenders, excluding automobile lenders, to disclose information in a form that is easy for consumers to read and understand; an example is the simplified terms you'll find on credit card applications.

A key component of Dodd-Frank, the Volcker Rule (Title VI of the Act), restricts the ways banks can invest, limiting speculative trading and eliminating proprietary trading. Effectively separating the investment and commercial functions of a bank, the Volcker Rule strongly curtails an institution’s ability to employ risk-on trading techniques and strategies when also servicing clients as a depository. Banks are not allowed to be involved with hedge funds or private equity firms, as these kinds of businesses are considered too risky. In an effort to minimize possible conflict of interests, financial firms are not allowed to trade proprietarily without sufficient "skin in the game." The Volcker Rule is clearly a push back in the direction of the Glass-Steagall Act of 1933 – a law that first recognized the inherent dangers of financial entities extending commercial and investment banking services at the same time.

The act also contains a provision for regulating derivatives such as the credit default swaps that were widely blamed for contributing to the 2008 financial crisis. Because these exotic financial derivatives were traded over the counter, as opposed to centralized exchanges as stocks and commodities are, many were unaware of the size of their market and the risk they posed to the greater economy.

Dodd-Frank set up centralized exchanges for swaps trading to reduce the possibility of counterparty default and also required greater disclosure of swaps trading information to the public to increase transparency in those markets. The Volcker Rule also regulates financial firms' use of derivatives in an attempt to prevent "too-big-to-fail" institutions from taking large risks that might wreak havoc on the broader economy.

Dodd-Frank also established the SEC Office of Credit Ratings, since credit rating agencies were accused of giving misleadingly favorable investment ratings that contributed to the financial crisis. The office is tasked with ensuring that agencies improve their accuracy and provide meaningful and reliable credit ratings of the businesses, municipalities and other entities they evaluate.

Aiding Whistleblowers

Dodd-Frank strengthened and expanded the existing whistleblower program promulgated by the Sarbanes-Oxley Act (SOX). Specifically, the Act:

— Established a mandatory bounty program under which whistleblowers can receive from 10 to 30% of the proceeds from a litigation settlement

— Broadened the scope of covered employee by including employees of the company as well as its subsidiaries and affiliates

— Extended the statute of limitations under which a whistleblower can bring forward a claim against his employer from 90 to 180 days after a violation is discovered

Criticism of Dodd-Frank

Proponents of Dodd-Frank believe the act will prevent our economy from experiencing a crisis like that of 2008 and protect consumers from many of the abuses that contributed to that crisis. Unfortunately, limiting the risks that a financial firm is able to take simultaneously decreases its profit-making ability. Detractors believe the bill could harm the competitiveness of U.S. firms relative to their foreign counterparts. In particular, the need to maintain regulatory compliance, they feel, unduly burdens community banks and smaller financial institutions — despite the fact that they played no part in the recession.

Such financial-world notables as former Treasury Secretary Larry Summers, Blackstone Group L.P. (BX) CEO Stephen Schwarzman, activist Carl Icahn and JPMorgan Chase & Co. (JPM) CEO Jamie Dimon also argue that, while each individual institution is undoubtedly safer due to capital constraints imposed by Dodd-Frank, these constraints make for a more illiquid market overall. The lack of liquidity can be especially potent in the bond market, where all securities are not mark-to-market and many bonds lack a constant supply of buyers and sellers.

The higher reserve requirements under Dodd-Frank mean banks must hold a higher percentage of their assets in cash, which decreases the amount they are able to hold in marketable securities. In effect, this limits the bond market-making role that banks have traditionally undertaken. With banks unable to play the part of market maker, prospective buyers will have a harder time finding counteracting sellers, but, more importantly, prospective sellers will find it more difficult to find counteracting buyers.

Critics believe the act will ultimately hurt economic growth. If this criticism proves true, the act could affect Americans in the form of higher unemployment, lower wages and slower increases in wealth and living standards. Meanwhile, it will cost money to operate all these new agencies and enforce all these new rules — over 225 new rules across a total of 11 federal agencies, to be exact — and that money will come from taxpayers.

  1. Volcker Rule

    The Volcker Rule separates investment banking, private equity ...
  2. Investor Protection Act

    A component of the Wall Street Reform and Consumer Protection ...
  3. Swap Dealer

    A swap dealer is an individual who acts as the counterparty in ...
  4. Consumer Financial Protection Act

    An amendment to the National Bank Act designed to identify and ...
  5. Too Big To Fail

    "Too big to fail" is a term for a business that has become so ...
  6. Investment Company Act of 1940

    The Investment Company Act of 1940 was created through an act ...
Related Articles
  1. Investing

    Trump's Vow to End Dodd-Frank Faces Big Hurdles

    Capitol Hill: President Trump and Republicans face daunting challenges as they move to dismantle Dodd-Frank
  2. Insights

    Fintech in the Trump Era: Regulatory Changes to Expect

    Will Trump’s administration try to repeal Dodd-Frank, or simply change financial regulations?
  3. Insights

    Top Bank Regulator Urges Trump to Keep Dodd-Frank (BAC, JPM)

    Cutting down on strict regulations imposed on financial institutions has been at the center on President-elect Donald Trump's policies to boost growth.
  4. Insights

    Volcker Rule: How It Will Affect You

    Learn how the Volcker Rule has a limited impact on individual investors but restricts the types of activities in which banks can engage.
  5. Investing

    Big Banks May Soar Higher After Post-Crisis Records

    As Trump's deregulation agenda starts taking clearer form, financial stocks have climbed higher.
  6. Insights

    Greenspan Fires a Salvo at Dodd-Frank Reforms

    Former Federal Reserve Chairman Alan Greenspan wants to repeal the Dodd-Frank financial reform bill, saying that it has not worked at all.
  7. Personal Finance

    Top 5 Banks That Are Too Big to Fail (JPM, BAC)

    Discover how the five largest banks have become so big that it would be detrimental to the financial health of the US economy if they fail.
  8. Insights

    Dodd-Frank: Republicans' New Plan to Replace It

    Republican leaders are working to replace Dodd-Frank.
  9. Investing

    How The Volcker Rule Affects You

    Find out if the Volcker Rule will just affect big banks, or if it's something you should worry about.
  10. Investing

    Trump's Bank Deregulation May Send Investors $120B

    Trump's plan to dismantle Dodd-Frank may free $120 billion in capital to pass on to investors
  1. What major laws regulating financial institutions were created in response to the ...

    Read about the major federal responses to the financial crisis of 2008, such as the Dodd-Frank Wall Street Reform Act and ... Read Answer >>
  2. Which federal regulatory agencies approved and are now responsible for enforcing ...

    Learn which federal regulatory authorities approved and are jointly responsible for the implementation and enforcement of ... Read Answer >>
  3. What is the purpose of the Volcker Rule?

    Learn about how the Volcker rule prohibits banks from engaging in certain activities, such as proprietary trading and having ... Read Answer >>
  4. What protections are in place for a whistleblower?

    Read about the possible protections offered to American whistleblowers who report on the illegal activities of their employers ... Read Answer >>
Hot Definitions
  1. Compound Interest

    Compound Interest is interest calculated on the initial principal and also on the accumulated interest of previous periods ...
  2. Income Statement

    A financial statement that measures a company's financial performance over a specific accounting period. Financial performance ...
  3. Leverage Ratio

    A leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt, or ...
  4. Annuity

    An annuity is a financial product that pays out a fixed stream of payments to an individual, primarily used as an income ...
  5. Restricted Stock Unit - RSU

    A restricted stock unit is a compensation issued by an employer to an employee in the form of company stock.
  6. Monero

    Monero is a digital currency that offers a high level of anonymity for users and their online transactions.
Trading Center