Norbert Michel
As we mark the 15th anniversary of the Dodd-Frank Wall Street Reform and Consumer Protection Act, it’s a great time to ask whether the law lived up to the hype. Admittedly, it’s rather difficult for someone who edited The Case Against Dodd-Frank to be objective, but let’s start with the law’s preamble.
Right there on page 1 (out of 850), it says that Congress enacted Dodd-Frank to:
…promote the financial stability of the United States by improving accountability and transparency in the financial system, to end “too big to fail,” to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.
Well, Dodd-Frank clearly failed to end “too big to fail” or to end bailouts; the 2023 banking crisis and the government’s response took care of those. And those two items go hand in hand with “improving accountability and transparency in the financial system,” so it’s pretty safe to judge the Act a failure based on the preamble.
Still, many critics like to blame those 2023 bank failures on the first Trump administration for signing into law the Economic Growth, Regulatory Relief, and Consumer Protection Act (the Economic Growth Act). But that law did not “gut” Dodd-Frank. In fact, it didn’t repeal one single title (out of 16) of Dodd-Frank. Objectively, it’s difficult to even say that the Economic Growth Act “rolled back” any of Dodd-Frank.
The quick version of what happened starts with Dodd-Frank’s requirement to impose “enhanced” regulations for bank holding companies with assets of more than $50 billion. Few seem to recall, but Section 165 of Dodd-Frank authorized the Fed to implement enhanced standards in a tailored fashion based on specific risks for specific companies. Under certain conditions, Dodd-Frank even authorized the Fed to establish an asset threshold above $50 billion.
So, what did the Economic Growth Act do? It essentially changed the threshold for the Fed’s enhanced supervision to $100 billion. It’s important to note, though, that the Economic Growth Act still left the Fed with the discretion to impose enhanced supervision on bank holding companies below the new $100 billion threshold. So, not such a radical change.
Regardless, the dirty little secret is that federal banking regulators didn’t really need Dodd-Frank to implement higher capital and liquidity ratios. In fact, federal regulators started stress tests before the Dodd-Frank Act was signed into law.
There are many problems with the existing bank capital regime and with how the Biden administration arbitrarily tried to implement more burdensome capital rules, but those problems go well beyond Dodd-Frank. Most of that capital framework reflects federal regulators’ decision to implement the Basel III framework, which has roots dating back to (at least) the 1980s.
Other Major Dodd-Frank Provisions
Aside from heightened capital standards, two of the main features of Dodd-Frank were the creation of the Financial Stability Oversight Council (FSOC) and Orderly Liquidation Authority (OLA). Title I of Dodd-Frank created the FSOC, a body of regulators charged with identifying risks to the financial stability of the United States and preventing the expectation of bailouts. The OLA, created by Title II of Dodd-Frank, was supposed to resolve large financial institutions in the event of their failure.
As we now know, the FSOC completely missed the 2023 banking turmoil, and the OLA has yet to be used. So much for the main pillars of Dodd-Frank. (By the way, Title XI of Dodd-Frank was also supposed to help end Fed or FDIC bailouts. As the 2023 banking crisis proved, Title XI merely formalized the type of collaborative bailout process between federal officials that was used during the 2008 crisis.)
Title VII was one of the other major Dodd-Frank changes. Title VII imposed a requirement to “clear” more over-the-counter (OTC) derivatives through central counterparties (CCPs). Aside from whether Title VII addressed the main causes of the 2008 financial crisis—it did not—it’s difficult to call Title VII a success.
Prior to the crisis, virtually all the counterparties using OTC derivatives were large banks that negotiated their own terms. If federal banking regulators truly needed more insight into those derivatives, they didn’t need any additional authority to get it. And if they wanted to implement higher capital requirements (or liquidity or even margin requirements) for those derivatives, they could have. They were already considered in banks’ capital requirements.
Simply put, Title VII did not reduce the overall risk from these derivatives; it merely concentrated that risk in the CCPs. (It’s also worth noting that the clearing requirement was the reason the Fed urged Congress to include Title VIII in Dodd-Frank, so that the CCPs would be plugged into the Fed in the event of a failure.)
The last major component of Dodd-Frank is the infamous Title X, the one that created the Consumer Financial Protection Bureau (CFPB). As I’ve written many times, it was not necessary to create a new government agency for consumer protection. Multiple federal agencies, as well as state agencies, were already carrying out that function. To create the CFPB, Title X consolidated most of the federal consumer protection statutes under the Bureau, but there was no reason it couldn’t have consolidated them under, just for example, the Federal Trade Commission. As for the new “abusive” standard of consumer protection, Dodd-Frank didn’t bother to define it. (Neither has the Bureau.)
The CFPB has been controversial from the beginning, partly because it was created with such an odd “independent” structure. One of the Bureau’s first significant acts was to go against the long-standing interpretation of the federal statute that governed real estate closings. It then retroactively applied its new interpretation and sued a mortgage company for more than $100 million, a lawsuit that ultimately made it easier for a US president to remove a CFPB director.
Controversial structure aside, some folks believe that creating the CFPB addressed the so-called predatory lending practices that caused the 2008 financial crisis. But there are a few problems with that story. First, it defies reason to think that all the borrowers who defaulted on their mortgages in 2008 were simply tricked into buying a home, not realizing they would have to make monthly payments of a certain amount.
Second, even if one believes this view, the supposed fix in Dodd-Frank was to require lenders to meet an ability to repay standard (enforced by the CFPB). But that standard was only an expansion of lending restrictions first implemented by the 1994 Home Ownership and Equity Protection Act (HOEPA). So, again, the idea that Dodd-Frank (or the creation of the CFPB) was a necessary fix rests on shaky ground.
Some folks hold a more subtle version of this so-called predatory lending view. In this telling, the real problem was that lenders failed to explain to borrowers with adjustable rate mortgages (ARMs) that their interest rates and mortgage payments might increase. Research has shown, however, that fixed rate mortgages (FRMs) showed just as many signs of distress as did ARMs. Regardless, Dodd-Frank did not outlaw ARMs, and it is undeniable that lenders had to disclose details of those mortgages prior to the 2008 crisis.
Finally, evidence of fraud in the mortgage market prior to the crisis is sparse and most often fails to support widespread consumer-facing fraud of the type prevalent in the predatory lending story. Instead, it shows that lenders (in some cases) ran afoul of their responsibilities to accurately document consumer information for institutional investors purchasing mortgages. For instance, as this US Housing and Urban Development report states, several studies show that “the vast majority of fraud involves misrepresentation of information on loan applications related to income, employment, or occupancy of the home by the borrower.” That’s a problem for the pro-Dodd-Frank camp for several reasons, but mainly because this type of fraud was already illegal prior to the 2008 crisis.
A Final Word on Dodd-Frank
There are many other small provisions of Dodd-Frank that have virtually nothing to do with the 2008 financial crisis. Most people have likely never heard of these provisions, such as Title IX’s securities lending reporting or self-regulatory organization fee filing provisions. These items likely mean a great deal to several financial practitioners, but that makes it very difficult for others to judge whether these provisions were even necessary. Arguably, many of these provisions created a regulatory mess where none previously existed.
Overall, it’s very hard to celebrate the Dodd-Frank Act’s 15th anniversary. The Act was based on a mistaken belief that the 2008 crisis stemmed from unregulated financial markets. It spawned hundreds of separate rulemakings and was the most extensive financial regulatory bill since the 1930s. It expanded the authority of existing federal regulators, created new federal agencies, and altered the regulatory framework for several distinct financial sectors. It imposed unnecessarily high compliance burdens, failed to solve the too-big-to-fail problem, and didn’t end bailouts.
Worse, it further cemented the notion that the federal government should plan, protect, and prop up the financial system. Fifteen years on, the Act stands not as a triumph of reform but as a case study in how sweeping legislation can miss the mark—and make future crises more likely, not less.