The 5 Best and 5 Worst Regulations in Dodd-Frank

This article was originally published by the Fiscal Times on Tuesday, July 19, 2011.

By Katherine Reynolds Lewis, The Fiscal Times

Next to health care reform, no other recent legislation has caught as much heat as financial regulation. Born of the subprime housing mortgage scandal and financial meltdown three years ago, the Dodd-Frank legislation provokes either glowing praise from consumers and reformists or angry diatribes from industry officials and Republican lawmakers.

In the year since President Obama signed the financial regulatory overhaul into law, the debate has largely shifted from the halls of Congress to the offices of the regulators who are writing some 250 new rules and delivering reports and guidance ordered by the law.

But Republicans and their industry allies are still pressing for changes to dilute the impact of the legislation. Their opposition forced Obama over the weekend to abandon plans to nominate former Harvard professor Elizabeth Warren, a harsh critic of the financial industry and darling of liberal groups, to head a new Consumer Financial Protection Bureau, and instead choose former Ohio attorney general Richard Cordray.

As the new financial regulatory landscape begins to take shape, supporters of the legislation crafted by former Sen. Christopher Dodd, D-Conn, and Rep. Barney Frank D-Mass., say the government and industry are better positioned to withstand a new crisis. "The reforms put in place in Dodd-Frank will help to provide for a more resilient and strong financial system that can help to grow the economy and create jobs," said Michael S. Barr, law professor at the University of Michigan.

Detractors claim the measure actually hurts the already troubled economy and job growth, leaving the financial system less stable than it was in 2008. "While it may have increased transparency, it has increased the amount of uncertainty. We've created a new cost of capital, called regulatory risk," said Rep. Randy Neugebauer, R-Tex., chairman of the House Financial Services Subcommittee on Oversight and Investigations.

With Dodd-Frank's one-year anniversary this Thursday, The Fiscal Times assessed the best and worst effects of the landmark law, for consumers and business .

The 5 Best According to Consumer and Reform Advocates


1. Mortgage market reform
Among the worst culprits in the financial meltdown were abuses in the mortgage industry, both mortgage originators that sold inappropriate, expensive loans to people who couldn't afford them and the companies that repackaged mortgages into securities without investigating the likelihood the debt would be repaid. So it makes sense that curbing abuses in the home loan market is one of the legislation's triumphs.

From new oversight of payday lenders and other non-bank financial firms, to requiring mortgage originators to verify that the borrower can repay the loan, Dodd-Frank aims to prevent any repeat of the housing collapse. Frank, the former House Financial Services Committee chairman, said a requirement that lenders keep some exposure to the mortgages they make is "the single most important piece of the bill."

2. Consumer Financial Protection Bureau
If it survives assaults from legislative critics, the CFPB will offer average Americans unprecedented protection from what Elizabeth Warren terms the “trips and traps” of the financial industry.

The bureau was designed to make sure financial companies follow the law, collect and respond to consumer complaints, enact new protections to ensure consumers are treated fairly, and promote financial transparency. Consumer advocates hail the new agency, which will be responsible for overseeing consumer financial products -- the only regulator charged with tracking products, rather than institutions like banks and securities firms. "One way of taking note of the size of the victory is the size and volume of the attack on the bureau," said Lisa Donner, executive director of Americans for Financial Reform, a coalition of labor, civil rights, senior, community and small business organizations.

The bureau has already proposed simplifying mortgage disclosure forms and this week will get the power to enforce a slew of fair credit, truth in lending and other consumer protection laws.


3. Oversight of derivatives
One thing that exacerbated the crisis in 2008 was the widespread use of over-the-counter derivatives http://www.thefiscaltimes.com/Articles/2011/04/01/Business-Groups-Seek-Swaps-Exemption.aspx , those private financial contracts between sophisticated institutions. The surge in derivatives trading took place without much understanding by regulators, investors or even the firms themselves of the risk.

When Lehman Brothers and American International Group threatened to collapse, it was the potential of derivatives to spread instability to those firms' trading partners, and their partners' partners, that caused the government to leap into action with bailout and merger plans.

Dodd–Frank gives regulators new power over and information about the opaque market for over-the-counter derivatives, and pushes more derivatives onto exchanges and into clearinghouses, making it less likely any one bad deal could start a chain reaction of failures and panic. "Loans made without adequate consideration of risk were the bullets," Frank said. "Derivatives were the gun."

4. Power to address systemic threats
Despite the crisis starting in lending markets where banks are the biggest participants, it was the possible chain reaction sparked by the failure of non-banks -- securities and insurance firms -- that led Congress to pass a $700 billion government bailout.

Dodd-Frank encourages coordination among the regulators to address all potential threats to the financial system, first by setting up a Financial Stability Oversight Council that has met five times and released required reports on potential dangers. It also grants new authority to unwind troubled firms, both financial and non-financial and requires big institutions to outline how they would be dissolved during a crisis in so-called "living wills."

5. Investor protections
Credit rating agencies like Standard & Poor’s and Moody’s did a lousy job of blowing the whistle on troubled financial industry debt packages: Dodd-Frank beefs up oversight of those firms. Other provisions give shareholders more say in matters such as executive compensation and implement a whistleblower program for corporate insiders to report wrongdoing. The law also strengthens rules for asset-backed securities to prevent a repeat of firms slicing and dicing mortgages into securities, when the credit quality of the underlying loans is unknown.

The 5 Worst According to Financial Firms and Their Allies

1. New capital standards and derivatives rules
Critics of Dodd-Frank are especially concerned that new derivatives rules and tough capital and risk standards will make the U.S. less competitive with its global competitors. "Rather than streamlining an already overly layered regulatory structure, modernizing and fixing existing regulators, and ensuring common regulatory approaches to global markets, this law missed the mark," said David Hirschmann, president of the Center for Capital Markets Competitiveness at the U.S. Chamber of Commerce. "It increased uncertainty for American businesses and hindered their ability to promote economic growth and create jobs."

Capital markets need risk to function and the ideal solution would rely on better information and transparency so investors can make informed decisions -- not elimination of risk.


"The worst thing about Dodd-Frank is the misguided effort to remove risk from the system," said Dan Crowley, a partner at K&L Gates and head of the capital markets reform group. "Risk is essential to the capital formation process. Empowering the government to reduce risk in the system will inevitably increase compliance costs and decrease investor returns."


2. Interchange fees
This measure was designed to protect consumers by reining in financial industry charges, but don’t count on it. Dodd-Frank directed the Federal Reserve Board to slash so-called swipe fees that banks charge merchants for debit card use, which bring in $20 billion of annual revenue. While an initial Fed proposal would have capped the fees at 12 cents per transaction, down from the existing average of 44 cents, the regulator last month set it at 21 to 24 cents per transaction in the face of furious lobbying by banks.

Even with that victory, don't expect banks to celebrate the new rules, which go into effect in October, or give up trying to raise consumer fees. "Government price controls over debit cards is the worst part of Dodd-Frank," said Scott Talbott, a senior vice president at the Financial Services Roundtable.. Even consumer advocates are dubious whether retailers will pass on their savings to customers.

3. The Volcker rule
During the meltdown, regulators -- and the market -- panicked over not knowing how banks' proprietary trading and the extent of potential losses might affect the financial system. Under a Dodd-Frank rule named for former Federal Reserve Board chairman Paul Volcker, banks are prohibited from proprietary trading and limited in investing in hedge funds and private equity firms. Its critics say depending on how regulators implement the provision, the Volcker rule could actually end up harming a bank or its customer’s ability to manage its assets -- not to mention cutting into profits and growth.

4. Overlapping rules of the road
Almost as bad as restrictive rules is the uncertainty the private sector faces in not knowing how the hundreds of new Dodd-Frank rules will be written. Just the fight over interchange fees gives a sense of how dramatically the impact can shift based on a regulator's interpretation. "The problem we have with Dodd-Frank, obviously very complex, lots of pieces to this puzzle, and we don't even know what the puzzle is supposed to look like when we're finished with it," Neugebauer said.

The law not only established new regulators, it shifted the lines of authority, forcing institutions to report and be accountable to multiple different federal agencies. "The problem with our regulatory structure is not the quantity of regulations, but the quality," Hirschmann said. "Even after the most expansive financial regulatory reform in our nation's history, we still have the same old system, only more of it."

5. No housing reform
Possibly the biggest failure of Dodd-Frank is what it neglected to address. Mortgage industry giants Fannie Mae and Freddie Mac, which were at the epicenter of the crisis, continue to dominate the housing finance market. The government guarantees or owns some 90 percent of existing home loans. There's no consensus plan to return private investors to the mortgage market, and very little political will to develop one.

"I wish we could deal with the housing finance system," said David Min, an associate director at the Center for American Progress. "We have taken strong measures to address risk. The question of liquidity is still an important one that remains to be resolved."