Dodd-Frank Wall Street Reform and Consumer Protection Act: How Does It Protect People?
by: R. Kurtz "Kurt" Holloway
People have the right to be treated fairly by big companies. Companies entice us to spend and invest our money with them. They should be honest in their dealings with us, respond to our complaints and follow the law like we do. When they don’t follow these rules it is appropriate for the government to act to protect our rights.
In 2008, financial markets crashed due to a number of causes. Excessive investment risk taken by financial institutions was a major factor. Ineffective government oversight was another. Greed and dishonesty in the financial industry was also a key ingredient. Many people bought houses they could not afford because they were given adjustable mortgage loans with very low (teaser) interest rates. When the rates adjusted up to normal, the borrowers defaulted. The housing market crashed and many people found themselves with more mortgage debt than house value. The economy tanked, millions of people lost their jobs and many companies who were deemed “too big to fail” were given a taxpayer-funded bail-out to prop them up. Many small banks and investment firms that were financially teetering on the brink of failure were bought up by larger banks. So, in the process some banks like JP Morgan Chase and Wells Fargo became even bigger than too big to fail. The American and world economies spiraled down into the deepest recession since the depression of the 1930’s. As is always true, the average person got hurt the worst. People wanted changes because no one was bailing them out of their financial troubles.
It was in this bleak atmosphere that Congress responded by enacting The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) in 2010 to help prevent this type of financial crisis from happening again. It was the most comprehensive financial reform since the Glass-Steagall Act passed in 1933. The Glass-Steagall Act was a federal law passed in response to the stock market crash of 1929. It prohibited banks from making risky investments with their depositors’ money. In 1999 the Glass-Steagall Act was repealed, partly because the banking industry convinced Congress that it did not need restrictions in order to protect depositors’ money. But by 2008 the house of cards built by Wall Street, banks and insurance companies collapsed and the Great Recession followed.
Here are a few of the key ways Dodd-Frank protects consumers, taxpayers and small investors:
1. Oversight to Head-Off the Failure of Financial Institutions. Dodd-Frank created The Financial Stability Oversight Council as a central monitor looking for excessive risks in the entire financial industry. If it sees danger, it will recommend that the Federal Reserve supervise any firm that may be at risk before it is in danger of failing. The Council is chaired by the Treasury Secretary, and has nine other members which are other federal agencies and the Federal Reserve Bank.
2. Limit Banks’ Investments with Depositors' Money. Dodd-Frank contains the Volcker Rule which prohibits banks from owning, investing in, or sponsoring hedge funds, private equity funds, or proprietary trading operations for their own profit. Banks made these investments with depositors’ money after Glass-Steagall was repealed in 1999. These prohibited investment operations were the kind that put depositors’ money at risk in 2008 and a big reason why some of the institutions on the brink of failure were bailed out with taxpayers’ money.
3. Protect Consumers from Unfair, Abusive Financial Practices. Before the 2008 financial crash, there were seven different regulators with authority over the consumer financial services marketplace. Accountability was lacking because responsibility was diffuse and fragmented. Consumers did not understand how their loans were structured due, in part, to confusing loan disclosure forms. There was no way to clearly compare loan terms from one lender to the next. Some lenders, including some mortgage lenders, credit card companies, payday lenders and others broke laws, lied to and took advantage of people any way they could. Dodd-Frank created an independent agency, The Consumer Financial Protection Bureau (CFPB), to set and enforce clear and consistent rules for the financial marketplace to assure that lenders followed the law and treat borrowers honestly and fairly.
4. Oversee Wall Street. Dodd-Frank also:
Regulates Risky Derivatives: Dodd-Frank requires that the riskiest derivatives, like credit default swaps, be regulated by the Securities Exchange Commission (SEC) or the Commodity Futures Trading Commission (CFTC). In this way, excessive risk-taking can be identified and brought to policy-makers' attention before a major crisis occurs.
Brings Hedge Funds’ Trades Into the Light: One of the causes of the 2008 financial crisis was that hedge funds and other privately held investment funds weren't regulated so no one knew what they were investing in or how much was at stake. Some of these firms sold risky mortgage loans to investors but made it difficult to for investors to see the danger. The investments failed and the housing market crashed.
Oversees Credit Rating Agencies: Dodd-Frank created an Office of Credit Ratings at the SEC to regulate credit ratings agencies like Moody's and Standard & Poor's. Many blame the agencies for over-rating some bundles of very risky and complex investments contributing to the financial crises.
Dodd-Frank includes many other provisions beyond the scope of this article. For further reading, I have listed some of the sources used for this article.
Harvard Law School: law.harvard.edu
The White House: Whitehouse.gov
American Bankers Association: aba.com
Davis, Polk & Wardwell, LLP – Summary of Dodd-Frank; July 2010