Dodd-Frank Turns Five – A Reason to Celebrate?

Levi Orbach |

The Dodd-Frank Wall Street reform had its fifth anniversary last week. President Obama signed the act on July 21, 2010, and promised that the law would deliver transparency and would stop the excessive risk-taking that nearly caused the financial system to crash. However, many issues remain unsettled.

One of the main goals of Dodd-Frank was to end taxpayer-funded bailouts. Therefore, it should prevent financial institutions from becoming too-big-to-fail. Moreover, the act was meant to end risky and abusive financial services practices and to make the financial system more transparent and accountable.

Therefore, Dodd-Frank created regulatory agencies, that oversee financial companies. Their task is to monitor and restructure or break up firms that are too-big-to-fail, too weak to withstand an economic downturn or pose risks to the financial system. That includes restrictions for banks investing in their own accounts.

Dodd-Frank Didn't End Too Big to Fail and Congressional Implementation is Slow

Five years after the signing of Dodd-Frank, many banks are still too-big-to-fail. In fact, the top bank holding companies have even become larger. Therefore, the act has been heavily criticized by politicians from all parties. Basically, the right wants to dismantle the act while the left wants to break up the critical banks and separate traditional banking from risky operations, similar to the Glass-Steagall regime.

Moreover, a report of the Corporate Reform Coalition (CRC) states, that banks are still “dangerously interconnected” and remain “vulnerable to sudden runs.” The reason is, that they borrow from wholesale lenders who can demand their money back every day. According to the CRC, banks are still engaging in risky derivative transactions, using taxpayer-backed deposits.

Furthermore, many financial institutions are still in the dark regarding the act's requirements. That creates uncertainty, because decision makers are not sure how the regulatory framework will develop. Additionally, Congress has been slow, a large chunk of the act's clauses have not been implemented so far.

Financial Institutions Have to Hold More Capital and Face Investment Restrictions

However, not all is bad. Dodd-Frank has in some ways made the industry safer. Financial institutions have to hold more capital which makes them less vulnerable. The Dodd-Frank Act Stress Tests monitor these capital ratios every year.

Moreover, the Volcker Rule restricts banks from certain kinds of trading that doesn't benefit their clients. However, the economists Sohhyun Chung and Jussi Keppo argue, that the Volcker Rule has made banks more likely to fail and less valuable. As they can't invest in certain products, they lend more, which is also risky but allowed by Dodd-Frank. Additionally, they pay more dividends, which means they have less money to cover bonds that went bad.

Dodd-Frank is a huge and complex reform and it's by no means perfect. It has failed to reach many of its goals, especially regarding too-big-to-fail. However, it has also caused progress in some areas of financial regulation, such as for example consumer protection.

The road to success may be to strengthen some aspects of Dodd-Frank and relaxing others. Senator Richard Shelby, for example, is expected to bring in some suggestions in a few weeks that go into that direction. Another important issue is to get a working and credible orderly resolution process in place. This will be the only way how Dodd-Frank could really end too-big-to-fail.

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