As the Trump presidency takes hold, the debate over Dodd-Frank is growing. President-Elect Donald Trump has promised to dismantle the banking reform act. Fed Chief Janet Yellen has promised to defend it. Congress has the power to change it. And, the battle has already begun.
The House just passed an amendment to the Dodd-Frank Act that could be the beginning of its unraveling. Although this bill isn’t expected to pass in the Senate during President Obama’s final days, it provides a glimpse of the fight ahead, under a Trump Administration.
The amendment that passed would change the way that federal regulators determine how important a bank is to the stability of the nation’s financial system, and how much oversight they should get. Banks that are determined to be crucial, or “too big to fail”, are called “systemically important financial institutions” — or SIFIs.
The threshold for oversight has been an ongoing debate by those who say the regulations are unreasonably harsh on smaller banks. Even the act’s co-author Barney Frank says it should have been more lenient toward smaller banks.
The just-passed bill would change the current threshold for stricter oversight from $50 billion dollars in assets to one that is determined on a case-by-case basis. The Financial Stability Oversight Council would be in charge of making that determination.
Most House Democrats are opposed to various parts of the bill including the provision about oversight. That’s due to Donald Trump’s pick for Treasury Secretary who will oversee the Council.
Although he isn’t confirmed, Trump would like former mortgage banker Steven Mnuchin to become the Treasury Secretary. There does appear to be a conflict of interest, since Mnuchin still holds a position on the board of CIT Group, which is a SIFI-designated bank…
But, the oversight of banks that are “too big to fail” is just one part of the Dodd-Frank Wall Street Reform and Consumer Protect Act. The entire Act is a 2,300 page document that contains a complex set of rules designed to prevent another financial meltdown.
It got its names from the two Democrats who authored it: former U.S. Senator Christopher Dodd of Connecticut and former U.S. Representative Barney Frank of Massachusetts.
Dodd-Frank created several new agencies to control the financial industry with the Financial Stability Oversight Council as the primary oversight entity. The FSOC pays special attention to banks that are considered “too big to fail”.
Banks are now subject to yearly stress tests meant to assess whether they have enough capital to protect themselves against major losses – so taxpayers won’t have to bail them out again. If they fail the test, the Council can order them to increase their reserves.
There’s also a new Federal Insurance Office that monitors insurance companies considered “too big to fail”.
And there’s a new Consumer Financial Protection Bureau that’s supposed to prevent predatory mortgage lending. That’s an outgrowth of the subprime mortgage market, which is often blamed for the 2008 financial meltdown. The Bureau also oversees credit card companies, auto loans, and other types of consumer lending.
The Volcker Rule was created to prevent banks from making risky investments and makes it illegal for banks to invest in hedge funds or private equity firms. There’s also a “skin in the game” aspect to that rule that requires banks to take at least 5% of the credit risk for any investment. The Volcker Rule also bans over-the-counter trading of derivatives. They must now be traded in centralized exchanges where any risk to the market can be noted and assessed.
Dodd-Frank also established the Office of Credit Ratings at the Securities and Exchange Commission. That office is in charge of making sure that investment ratings on businesses and municipalities are accurate. Credit rating agencies were accused of handing out “misleadingly favorable” ratings leading up to the financial crisis.
Dodd-Frank protects whistleblowers and establishes a “bounty” program. Whistleblowers can get 10 to 30% of the proceeds from any legal settlement.
While some say all these new rules have made Wall Street safer, critics complain that it’s hobbling the economy because the financial sector has much less capital and much less liquidity now.
Dodd-Frank is a massive act that has been mostly implemented already, so a simple “repeal” is not likely. As CNBC writes, it also goes against Trump’s populist message to make America great again for the American people. After all, Dodd-Frank was put into place to protect taxpayers, not big banks.
That’s why it may be hard for Trump to explain to his fans why he’s choosing a big Wall Street banker as his Secretary of the Treasury. It sounds a bit like putting a fox in charge of the hen house… I personally never understood how Trump supporters thought a billionaire was one of “them.” As one of the elites, he’s never shown a lot of compassion for the unemployed or the lower working class – until running for President.
Senior economic analyst at Bankrate.com Mark Hamrick is quoted by CNBC as saying: “It doesn’t look good for Donald Trump the populist to be essentially disemboweling what was the principal regulatory response to the financial crisis.” He says if the next step is to “amend” the act, then: “You have to begin by acknowledging that there probably are very few lawmakers who thoroughly understand the law in the first place.”
CNBC writes that most of the backlash over Dodd-Frank has come from the banking system. They say it has made it more difficult to expand lending, and that it’s penalized smaller community banks.
The legislation has strong support from outspoken Democratic Senator Elizabeth Warren from Massachusetts. She has pledged a “battle that’s going to be fought hard” over financial regulations put into place in response to the Great Recession. Politico writes that she may even push for changes that make those rules tougher on banks.
GOP Representative Jeb Hensarling of Texas could be one of her opponents in this battle. Hensarling authored legislation last year called the “Financial Choice Act”. Choice stands for “Creating Hope and Opportunity for Investors, Consumers and Entrepreneurs”.
The bill would scrap most of the more restrictive measures under Dodd-Frank, including the Volcker rule. It hasn’t come up for a vote yet but Hensarling is reportedly optimistic is will get to the floor next year. It may have more trouble in the Senate though where Republicans only hold a simple majority. But this legislation could serve as a blueprint under the Trump administration for any changes to Dodd-Frank.
The Insurance Journal writes that some aspects of the CHOICE Act may appeal to the “populist anger” toward big banks among Tea Party members and Trump supporters. One provision would prevent future bank bailouts by placing limits on how central banks can lend money to financial institutions.
It appears that right now, the President-Elect’s promise to tear Dodd-Frank out by the roots will be more of a process of amendments, with plenty of battles to be fought on both sides.
Any changes that make it easier to get home loans is something the nation needs, but not at the expense of banking stability. The pot is only starting to simmer on the Dodd-Frank front.