What is the Dodd-Frank Act?

Legislators passing Dodd-Frank were like frustrated parents laying down the law...

Before the 2008 crisis, financial institutions were like unruly teenagers running around without much oversight. When they got in trouble and hurt people, the parents had to set ground rules to try to prevent it from happening again. And the parents wanted to make clear they might not bail the kids out next time.

Every time the economy has taken a major plunge in the past century, it has served as a wake-up call for lawmakers. After the Great Depression, Congress established the Federal Deposit Insurance Corporation to protect deposits in case banks failed. The Great Recession of 2008, also triggered a legislative response. That year, investment banking giants Bear Stearns and Lehman Brothers both collapsed. It was a sign of the crisis come: Risky mortgage lending practices combined with falling housing prices led to widespread foreclosures, followed by reduced credit available for businesses and rising unemployment. By 2010, nearly 40% of American households had a member who was unemployed, had fallen behind on house payments or had their house value fall below their mortgage value. Many experts blamed predatory lending, securities fraud, and other abusive or risky practices on the part of financial institutions — and traced that behavior back to deregulation of banks in previous decades.

President Obama’s administration responded quickly. By June 2009, his economic team released guidelines for reforming the financial system. Senator Chris Dodd and Congressman Barney Frank sponsored legislation based on this framework, and it passed a year later. The Dodd-Frank Act was complex — It weighed in at more than 2,000 pages and included around 400 new rules for 20 agencies. It was seen as the most ambitious reform of the financial industry since the Great Depression.

The law took many steps aimed at improving oversight of financial systems:

• It created the Financial Stability Oversight Council (FSOC). Chaired by the Treasury Secretary, its job is to scan for threats to the financial system and take action when risk gets too high. The FSOC can break up financial firms that are a “grave threat” to stability, force institutions to increase the amount of money they keep in reserves, or liquidate or restructure financially weak firms. Lawmakers felt that, before the crisis, various regulators focused only on narrow parts of the economy, leaving gaps in oversight. The council would look at the big picture to identify risks to financial stability that could otherwise fly under the radar.
• The Dodd-Frank Act formed the Office of Credit Rating, part of the Security and Exchange Commission, to ensure accurate ratings and avoid conflicts of interest. Credit rating agencies evaluate the riskiness of different kinds of debt to keep investors informed. Many observers blamed these agencies for playing a role in the crisis by giving overly sunny ratings to risky mortgage-backed securities.
• The law established the Federal Insurance Office, housed in the Treasury Department, to monitor the insurance industry and make sure no insurance companies create undue risk.
• It gave the SEC more power to regulate risky financial products that were widespread in the lead-up to the crisis. That includes derivatives, which are securities whose value is based on an underlying asset, like mortgages, currencies, or commodities like oil and gas. The most risky derivatives are now traded in a clearinghouse that helps regulators keep an eye on them and identify risks before a big crisis happens.
• Dodd-Frank introduced new protections for whistleblowers, or people with inside knowledge that reveals wrongdoing in the financial services industry. Employers could no longer retaliate against whistleblowers for coming forward, and the whistleblowers could get a financial reward of up to 30% of the sanctions collected by the SEC or in a criminal case.
• It required all hedge funds to register with the SEC and provide information about their portfolios and behavior.

Also part of the Dodd-Frank Act, the Volcker Rule aims to keep banks from speculating with their own money — in other words federally insured deposits. The rule bars banks from trading in things like derivatives and generally blocks them from having an ownership share in hedge funds or private equity funds (which tend to make speculative investments). The rule, which went into effect in 2013, was named after former Federal Reserve Chairman Paul Volcker, who came up with the idea. In August 2019, Trump administration banking regulators rolled back some of the rule’s restrictions on risky trades.

One major way the Dodd-Frank Act tried to protect consumers was to create a whole new agency for the job: the Consumer Financial Protection Bureau. The agency works to educate consumers so they can make good financial decisions, investigates consumer complaints, creates rules to regulate financial products and services, and fines companies that violate them. A big part of the agency’s mandate was to make sure customers understood mortgages before signing them and to prevent predatory mortgage lending of the kind that led to the 2008 crisis.

The law also tried to help consumers who had suffered because of predatory lending practices before the crisis. It gave $1 billion to states and cities to redevelop foreclosed properties and another $1 billion to help homeowners who’d lost their jobs cover mortgage payments. It also reformed the mortgage industry to help prevent these practices from reoccurring — for instance, requiring lenders to be reasonably sure borrowers could repay loans and taking away incentives for lenders to steer consumers toward more expensive loans.

The Federal Reserve, also known as the Fed, is the country’s central bank. Its job is to keep the economy healthy, including keeping employment high, prices stable, and interest rates moderate in the long term. During the financial crisis, the Fed relied on an obscure rule to provide emergency loans to large investment firms that were not banks. This included special help for struggling firms seen as “too big to fail” — AIG, Bear Stearns, Citigroup, and Bank of America. These actions raised questions about what kind of financial institutions the Fed should bail out, and whether bailouts were a good thing at all. The Dodd-Frank Act limited the Fed’s ability to lend to certain institutions and required the Treasury Secretary to approve emergency loans. It also directed the Fed to do an annual “stress test” of banks and other financial institutions with more than $100 billion in assets to see how they would fare in various economic scenarios. The Dodd-Frank Act also allowed the Government Accountability Office to audit the Fed’s actions.

Yes. In May 2018, Congress approved a bill easing rules for thousands of small and medium-sized banks, and President Trump signed it into law. That meant just 10 of the country’s biggest banks — those with more than $250 billion in assets — would still be subject to the law’s tougher regulations. The rollback also gave banks with less than $10 billion in assets a pass when it came to the Volcker Rule. Proponents of the change said it will help community banks, who can now lend more to small businesses and consumers. Critics voiced concern that the rollbacks could lead to the kind of reckless behavior that created the financial crisis.

Republicans in Congress and President Trump have pushed to further weaken Dodd-Frank. One example was a proposal from regulators to loosen limits on how much big banks can borrow. Under the Trump administration, the Consumer Financial Protection Bureau has also halted ongoing investigations into financial firms.

You can read the full text of the legislation on Congress’s website.