This week marks the 5th anniversary of the signing of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Commonly referred to as “Dodd-Frank,” the protocol was introduced in 2010 by President Obama and set in motion by the U.S. Commodity Futures Trading Commission (CFTC) in the aftermath of the 2008 financial crisis. The goal of Dodd-Frank was to protect consumers from risky behavior, abuse and financial loss.
The CFTC was in charge of writing the rules to regulate the swaps marketplace and lower investment risk in various parts of the U.S. financial system. Chairman Gary Gensler, CFTC chairman at the time said the following:
“The Wall Street reform bill will – for the first time – bring comprehensive regulation to the swaps marketplace. Swap dealers will be subject to robust oversight. Standardized derivatives will be required to trade on open platforms and be submitted for clearing to central counterparties. The Commission looks forward to implementing the Dodd-Frank bill to lower risk, promote transparency and protect the American public.”
The Dodd-Frank Act was named after U.S. Senator Christopher J. Dodd and U.S. Representative Barney Frank who acted diligently as one to put the act into place.
Swap Regulation
The main purposes of Dodd-Frank was to reform the regulation of swaps. It was thought at the time that these products, which had not been regulated in the United States up until that time, were the main cause of the 2008 financial crisis.
But the Dodd-Frank Act ended up with additional responsibilities. Chief among them was the need to end any and all risky and abusive financial practices, to make the financial system more transparent and accountable and to prevent institutions from becoming too big and ungovernable. In addition, the Act was meant to prevent the government from coming in and bailing out companies and banks at the expense of consumers.
In order for these goals to be actualized, the CFTC divided up the responsibility for its regulation and enforcement among several different agencies which are still in force today.
The Financial Stability Oversight Council and Orderly Liquidation Authority both act to monitor the performance of companies deemed “too big to fail.” The Orderly Liquidation Fund provides monetary assistance to financial companies that have been placed in receivership due to their financial vulnerability. The funding is offered in hopes that these companies can remain solvent and not be liquidated at the expense of its shareholders.
Along with the Orderly Liquidation Fund, the Financial Stability Oversight Council is also in a position to liquidate or restructure weak and at risk financial companies. In addition, the Oversight Council can decide if and when to divide up a banking conglomerate that has become too big and unwieldy and whose size may present a threat to the financial system some time down the road. In the same vein, the new Federal Insurance Office is in charge of pinpointing insurance companies that present a possible financial threat and observing them on a continual basis so as to ensure their financial viability.
Volcker Rule
Another key component of the Dodd-Frank Act is the Volcker Rule which limits the manner in which banks can invest, limits speculative trading and eliminates proprietary trading by the bank. This change makes it more difficult for banks to be profitable.
The Consumer Financial Protection Bureau (CFPB), another agency initiated through Dodd-Frank and still heavily involved in today’s mortgage arena, was given the responsibility of preventing mortgage lending that could prove destructive to economic stability. The CFPB also helps consumers by overseeing the way mortgage paperwork is presented and by shrinking the incentives used by mortgage brokers to induce buyers into taking out more expensive loans. Since its inception, the CFPB has made several important changes in the way credit card companies and other consumer lenders disclose their terms to consumers. All loan terms and conditions must be presented in a clear and easily understandable format.
The Dodd-Frank Act also launched the SEC Office of Credit Ratings (OCR) whose goal is to monitor the activities of credit rating services and to conduct examinations of registered Nationally Recognized Statistical Rating Organizations (NRSROs) to “assess and promote compliance with statutory and Commission requirements.”
Annual Stress Tests
It’s been five years since its implementation and the Dodd-Frank Act is still in place and seems to have achieved its goals. But in order to keep tabs on large financial companies and vast banking institutions, Section 165(i)(2) of the Dodd-Frank Act requires national banks and federal savings associations with total consolidated assets of more than $10 billion and financial companies with over $50 billion in worth to conduct what is considered annual stress tests. The Office of the Controller of the Currency (OCC) published its first stress test rules on October 9, 2012 which outlined the definitions and requirements for proper application, reporting, and disclosure. The new rule also set November 15th each year as the date for each selected institution to provide the required annual reports. Some of the rules of the stress test were modified in October 2014.
The results of these company-run stress tests provide the OCC with vital information that can be used in the management of the financial health of large companies which are deemed to have the potential of becoming a financial risk some time in the future. With the results of the test, the OCC can offer assistance to the institution in hopes of avoiding this negative outcome by ensuring the company or bank enough capital for their continued operation until the monetary crisis has been removed and the financial stress has dissipated.
The CFTC Division of Enforcement follows up on alleged violations of the Commodity Exchange Act and Commission regulations and can initiate enforcement actions against individuals and firms registered with the Commission as well as those involved in commodity futures and option trading on specific domestic exchanges and anyone acting improperly in market futures and options contracts. Any enforcement action taken is posted in detail on the CFTC website for all to see.
But even with all the rules and regulations, the question remains just how effective the Dodd-Frank Act can be when it comes to ensuring that the country never suffers through another financial crisis like the one in 2008. Despite assurances from the Treasury Department that the days of “too big to fail’ are over, the markets are still wary that that government would allow the big banks to go down without stepping in to bail it out in one form or another. Hopefully, we won’t have to face this decision any time soon.