What Is Dodd-Frank, and What Happens if It’s Repealed?
President Obama’s legacy may not have the longevity that he had hoped for. The Republican Party unexpectedly swept the congressional and presidential elections in November. As a result, many signature Obama-era policies are up for elimination.
President Trump has spoken a lot about his plan to repeal and replace the Affordable Care Act. But another proposed repeal has gotten far less discussion: Dodd-Frank.
What is Dodd-Frank, in a nutshell? It’s the most extensive financial regulation policy since the reforms after the Great Depression. It created a host of new protections, rules and oversight authorities. And its goal is to prevent another 2008-style financial crisis.
It’s also a controversial law on both sides of the aisle. Many conservatives feel that Dodd-Frank has bogged down the U.S. economy with harmful regulations. Meanwhile, many progressives argue that it hasn’t gone far enough in reigning in Wall Street excesses.
Let’s dive into the details of this wide-reaching regulatory reform. We’ll also look at some of the potential effects if it’s repealed.
What Is Dodd-Frank?
First of all, it’s more than 2,300 pages long. It would be impossible to summarize every single provision of Dodd-Frank in this article. But in the simplest terms, Dodd-Frank is an extensive regulatory framework for the financial sector. It was designed to control systematic risks to the American economy.
Part of this meant creating a series of new financial oversight agencies. The Financial Stability Oversight Council identifies risks to the financial industry. FSOC works with banks, hedge funds and insurance companies. They adjust reserve requirements and create crisis plans.
Dodd-Frank also created the Consumer Financial Protection Bureau. The CFPB serves as a watchdog against banking policies which abuse customers. Most recently, it sprang into action over the opening of bogus accounts by Wells Fargo (NYSE: WFC).
Another important part of Dodd-Frank is the Volcker Rule. It prohibits investment bankers from making transactions which are solely for their own profit. It limits them to investments which benefit their clients.
The Volcker Rule is often cited as the most important part of Dodd-Frank. Yet it’s now been six years since the passage of the law and the feds haven’t finished implementing the rule yet. And many large banks haven’t even started.
This is an incomplete summary of Dodd-Frank’s provisions, but you get the idea – It’s a lot of new rules. Critics argue that all of this regulatory burden has hampered economic growth. The diagram below puts the regulatory web into visual terms. And this isn’t a political ad put out by Dodd-Frank critics. It was made by the chairman of the SEC.
Dodd-Frank hasn’t necessarily accomplished its main goal of promoting stability in the financial sector. It’s hard to argue that you’re working to end “too big to fail” with a law that instructs regulators to classify certain banks as “too big to fail.” That’s part of the reason why Dodd-Frank may be going bye-bye under President Trump.
What Happens if It’s Repealed?
Critics of Dodd-Frank argue that it has actually consolidated power within the investment banking space. It slapped banking regulations on non-bank financial firms like GE Capital (NYSE: GE). In the process, it may have reduced the availability of private funding for startups. Pro-repeal economists say that removing these regulations will be a boon to American entrepreneurs.
Some economists advocate giving up on the Volcker Rule in particular. They say it could increase the liquidity of debt markets. Even if banks are investing in debt for their own profit, they’re still functioning as market-makers.
However, a Dodd-Frank repeal would certainly carry some risks. Without the CFPB, there wouldn’t have been a clear procedure for how to deal with Wells Fargo’s fraudulent sales practices.
And while the Volcker Rule hasn’t exactly met its goals, there could be consequences to abandoning it. The legislation was designed to prevent the type of self-interested trading that contributed to the global financial crisis.
In the late 2000s, large American banks were selling subprime CDO’s and MBS’s to foreign governments, then shorting these debt instruments themselves. That type of destructive behavior could be legitimized again if Dodd-Frank becomes history.
So, let’s recap. What is Dodd-Frank? It’s one of the strongest and most complicated financial regulation reforms in American history. What happens if it’s repealed? It’s hard to say. The economy may benefit from decreased regulatory drag. Dodd-Frank certainly introduced a lot of it. But at the same time, we could be exposing ourselves to the kind of risks that created the Great Recession.
For now, it’s best not to jump to conclusions. If the last few weeks have taught us anything about the Trump administration, we should know better than to speculate about what the President will do next.
To paraphrase Trump at the final debate, he’ll keep us in suspense.