As Republicans move to make substantial changes in the 2010 Wall Street reform regulations known as the Dodd-Frank Act, Miami Law's Stanley I. Langbein explains what is at stake and why it matters.
Langbein is a Professor of Law at University of Miami School of Law, teaching courses in banking law and regulations, secured transactions, negotiable instruments, Federal income taxation, and international taxation. He was an attorney/adviser in the Office of International Tax Counsel of the Treasury Department. He is the author of "Federal Income Taxation of Bank and Financial Institutions" and is currently working on a new treatise, "Federal Regulation of Banking Organizations," to be published by Civic Research Institute/Delta Hedge in 2017.
What is Dodd-Frank and what was it formed to accomplish?
Dodd-Frank is a sweeping, significant law passed in 2010 in response to the global financial crisis of 2007 and 2008. It was enacted both to prevent the abuses that led up to the crisis, including protections for consumers, and to construct a mechanism to handle any such crises that might develop in the future.
What abuses did it seek to correct, and how did it seek to correct them?
Primarily it sought to bring under Federal regulation institutions like insurance companies and brokerages, which function like banks and pose the same kinds of threats to financial stability as banks, but which had not previously been regulated to the same extent banks were regulated.
How did it tighten regulation of banks and these other financial companies?
Mostly it required these institutions to hold more capital, and to rely less on borrowed money, and also regulated the extent to which the largest banks had risky interconnections with each other.
Did it change the underlying philosophy of bank regulation?
It shifted away from the traditional focus of regulation, which aimed at assuring the individual banks and other institutions were “safe and sound,” to a focus on whether particular kinds of financial transactions and innovation posed a “systemic risk” to the financial system generally.
Did the law end the existence of “too big to fail” banks?
For the most part, it did. It set up a mechanism for dealing with the failure of “systemically important” nonbank financial institutions parallel to the existing system for banks and ensured that no taxpayer monies would be used to “bailout” such institutions.
How did the law protect consumers, in general?
The law established the Consumer Financial Protection Bureau, the brainchild of now-Senator Elizabeth Warren.
How does that Bureau protect consumers?
There are a range of consumer protection laws that have been on the books for nearly fifty years, but which were largely gutted by the Federal Reserve and other regulators who had been charged with enforcing it. The law transferred responsibility for enforcing those laws to the new Consumer Financial Protection Board and protected that Board from lobbyist influence by giving it an independent budget, and making its officers independent of Federal Reserve interference.
Did the law protect consumers with respect to home mortgages? What about consumers with respect to securities accounts?
Yes, it enacted a whole new range of Federal regulations applicable to banks, lenders, and mortgage brokers. Yes, it also enacted a whole new range of Federal regulations applicable to securities brokers and dealers.
Has the law worked?
For the most part, it has worked well both in giving consumers protection and in making the banks stronger and better able to withstand economic stress. The new mechanisms for responding to the incipient crisis have yet to be tested.
What are the Republican trying to change and why?
First and foremost, the Republicans want to gut the Consumer Financial Protection Bureau, or at least to destroy its independence. To the corporate community – in particular, the United States Chamber of Commerce, consumer protection has long been anathema, and they have done all they could to block or counteract it.
What about the capital requirements and other limitations on banks?
The Republicans would like to cut back or eliminate those things too. Relying on debt, or “leverage,” is profitable for banks, which can lend out funds at a higher rate than they have to pay for the funds, which gives them a return on virtually zero net investment. But leverage is also risky, and to some extent deposit insurance enables banks to shift these risks to the taxpayer – a “heads-I-win, tails-you-lose” proposition. The banking industry believes the new rules restrict leverage too much – sometimes their position is unreasonable (they just want to make more money), other times it is reasonable (the regulations restrict profits more than is necessary to protect the public, or are just out and out punitive).
Are the Republican positions unreasonable?
Not entirely. The law was an enormous law, well over a thousand pages, and some of its provisions were clearly unnecessary or even silly, particularly as they applied to smaller banks. Still, the restrictions on larger institutions were clearly necessary, so some degree of overkill was unavoidable.
What kind of provisions would you characterize as silly?
For instance, one of the principal causes of the financial crisis was that the statistical rating agencies – Moody’s, Standard & Poor, Fitch – overrated mortgage securities. So Dodd-Frank prohibited Federal agencies from referencing those ratings in any regulations. This means that smaller community banks, which buy a lot of local municipal bonds, must do their own “due diligence” on those bonds because they can’t rely on the ratings. But the rating of municipal bonds was not a problem, during the crisis or otherwise, so this sort of rule has hurt both the smaller banks and municipal and state borrowers. And the rule, as applied to them, serves no meaningful purpose.
Will the law succeed in avoiding another global crisis?
Nobody knows. It has succeeded so far, but there are those who believe that the last crisis was only “papered over,” and another one may be on the horizon. Nobody can deny that Dodd-Frank has made the system safer, but there is an ongoing debate about its costs, both to the banks and to the economy.
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