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Robert Longley is a U.S. government and history expert with over 30 years of experience in municipal government and urban planning.
Published on October 14, 2020The Dodd-Frank Act, officially titled The Dodd-Frank Wall Street Reform and Consumer Protection Act (H.R. 4173), is a massive United States federal law enacted on July 21, 2010, which makes sweeping reforms to the operations of all federal financial regulatory agencies, as well as most areas of the U.S. banking and lending industry. Named for its congressional sponsors, Senator Christopher J. Dodd (D-Connecticut) and Representative Barney Frank (D-Massachusetts), the Dodd-Frank Act was enacted in response to the Great Recession of 2008. In May 2018, President Donald Trump signed a law rolling back several provisions of the act.
Beginning in December 2007 and lasting well into 2009, the Great Recession triggered the worst economic disaster in the United States since the Great Depression of 1929. Left unemployed, millions of Americans lost their homes and savings. As the recession drug on, the poverty rate in the United States increased from 12.5% in 2007 to more than 15% by 2010.
In September 2008, simmering fear and instability in the banking industry—the foundation of the U.S. financial system—boiled over when Lehman Brothers, one of the largest investment banks in the United States, collapsed. As fears of a 1929-level depression gripped the nation, investors left the market and stock values plummeted until Wall Street ground to a halt. With consumers falling into poverty, and now with no ready source of financing, major companies and small businesses alike struggled to survive.
Politicians and economists blamed the recession on the federal government’s failure to regulate and oversee the nation’s financial institutions. Free of proper government regulation, banks were charging customers hidden fees and making so-called “toxic” mortgage loans to financially unqualified borrowers.
Additionally, investment firms were becoming a “shadow banking system,” accepting deposits, making loans, and conducting other banking services without the same level of regulation applied to traditional banks. As banks and investment banking firms failed under the weight of their bad loans, consumers and businesses lost access to credit.
Now well aware of the depth of the crisis and under intensifying public pressure, lawmakers stepped in.
In June 2009, President Barack Obama first proposed what would become the Dodd-Frank Act in what he called a “sweeping overhaul of the United States financial regulatory system, a transformation on a scale not seen since the reforms that followed the Great Depression.”
In July 2009, the House of Representatives took up the initial version of the bill. In early December 2009, revised versions were introduced in the House by Financial Services Committee Chairman Rep. Barney Frank and in the Senate by former Senate Banking Committee Chairman Christopher Dodd. The House passed its initial version of the Dodd-Frank Act on December 11, 2009. The Senate passed its amended version of the bill on May 20, 2010, by a vote of 59 to 39.
The bill then moved to a conference committee to resolve differences between the House and Senate versions. The House approved the reconciled bill on June 30, 2010. The final passage of the bill came on July 15, when the Senate passed it by a vote of 60 to 39. President Obama signed the bill into law on July 21, 2010.
The Dodd-Frank Act contains 16 areas of reforms. Some of the most significant include:
To prevent the bank closures that had fueled the recession, Dodd-Frank created the Financial Stability Oversight Council (FSOC) to watch for risky practices throughout the banking industry. Among many other regulatory powers, the FSOC can order banks that grow “too big to fail” to be broken up.
If the FSOC determines that a bank has become too large, it can order the bank placed under the control of the Federal Reserve, which can require it to increase its reserves—money that may not be used for lending or operating costs. Also, banks are required to develop plans for shutting down in an orderly manner if necessary.
Chaired by the secretary of the Treasury, the FSOC gets input from the Federal Reserve, the Securities and Exchange Commission (SEC) and the newly created Consumer Financial Protection Bureau or CFPB. Through the SEC, the FSOC also regulates risky non-bank financial vehicles like hedge funds.
As a key provision of Dodd-Frank, the Volcker Rule prohibits banks from having any involvement in hedge funds, private equity funds, or any other risky stock trading operations for profit. Banks are allowed to engage in limited trading if necessary. For example, banks can take part in currency trading to offset their holdings in foreign currencies.
The Volcker Rule also allows the government to better regulate risky derivatives, like credit default swaps. Under Dodd-Frank, all hedge funds must register with SEC. It was the trading of derivatives by hedge funds that led to the subprime home mortgage crisis that resulted in so many mortgage delinquencies and foreclosures.
Within the Treasury Department, Dodd-Frank created the Federal Insurance Office (FIO) specifically to identify insurance companies like AIG that had put the nation’s entire financial system at risk. Suffering a severe liquidity crisis, AIG saw its credit rating downgraded in September 2008. Considering AIG one of the “too big to fail” institutions due to the number of individuals and businesses it served, the U.S. Federal Reserve Bank was forced to create an $85 billion—taxpayer-funded—emergency bailout fund to help keep AIG afloat.
Dodd-Frank created the Office of Credit Rating under the SEC to regulate bond credit rating agencies like Moody's and Standard & Poor's. Different from consumer credit rating companies like Equifax, bond credit rating agencies evaluate the creditworthiness of corporate or government bonds. The bond credit rating agencies were blamed for helping to cause the 2008 recession by misleading investors by over-rating the actual value of mortgage-backed securities and their derivatives. Under Dodd-Frank, the SEC can review the practices of bond credit rating agencies and de-certify them if necessary.
To protect consumers from “unscrupulous business” practices by banks, the new Consumer Financial Protection Bureau (CFPB) works with large banks to prevent transactions that harm consumers, such as risky lending. The CFPB also requires banks to supply consumers with “plain English” explanations of mortgages and credit scores. Also, the CFPB oversees credit reporting agencies, credit and debit cards, and payday and consumer loans, except for auto loans made by dealers.
Dodd-Frank strengthened the existing whistleblower program created by the Sarbanes-Oxley Act of 2002. Specifically, the law created an SEC “whistleblower bounty program” under which people who report confirmed incidents of fraud or abusive practices anywhere within the financial industry are entitled to 10% to 30% of the proceeds from litigated settlements or court rulings.
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Dodd-Frank imposed dozens of strict regulations on America’s banks and credit unions. This angered small local banks that said the regulations were overly burdensome on them, and President-elect Donald Trump, who called Dodd-Frank a “disaster” and promised to “do a big number” on the 2010 law.
On May 22, 2018, Congress passed the Economic Growth, Regulatory Relief and Consumer Protection Act (S.2155) exempting all but the largest U.S. banks from many of the Dodd-Frank regulations. President Trump signed the partial repeal into law on May 24, 2018.
The rollback prevents the Federal Reserve from designating the small banks as being “too big to fail,” meaning they no longer have to hold as much in assets to protect them against a cash crunch. Smaller banks are also exempted from the Volcker Rule. Banks with less than $10 billion in assets can now use depositors’ money for highly risky investments.
