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The term Dodd-Frank is a complicated and comprehensive piece of legislation enacted by Congress during 2008's great recession, and its full title is the Dodd-Frank Wall Street Reform and Consumer Protection Act.
What you should know
Simply put, Dodd-Frank regulates banks, and it evolved in part to prevent other financial institutions from collapsing after the fall of Lehman Brothers. The bill, enacted in 2010, was named after its sponsors, Sen. Christopher Dodd (D-CT) and Rep. Barney Frank (D-MA). However, some regulations are subject to change and not every provision is in place. While the bill is quite lengthy and deals with several major areas of banking reform, it is best to focus on what was intended to be the main thrust of the law.
One of the major goals of this bill is to subject financial institutions to a variety of restrictions, coupled with the need for breaking them up if it is determined that they are “too big to fail.” To accomplish this Dodd-Frank established the Financial Stability Oversight Council (FSOC), which monitors risks that would have an effect on the financial industry.
The Treasury Secretary chairs this council, and its nine members include the Securities and Exchange Commission (SEC), the Consumer Financial Bureau (CFPB) and the Federal Reserve. Te council also oversees other financial institutions, including hedge funds. If it determines that a bank has become too large, the Federal Reserve can step in and have the bank add to its “reserve requirement,” funds that cannot be used for lending or to cover business expenses. Banks must also develop a plan for a rapidly and orderly closing that would be followed if they ever became insolvent.
Explaining the Volcker Rule
This part of the bill makes it illegal for financial institutions to own, invest in or sponsor private equity funds, proprietary trading operations or hedge funds in order to realize a profit. To assist bankers in determining which funds are unacceptable and which funds will benefit their customers, they have two years in which to conform to the rule prior to enforcing it. Note that under the Volcker Rule, trading is permitted when bankers need it in order to conduct business. For example, they are allowed to offset the holdings they have in a foreign currency by engaging in currency trading. More Information on simple business financiing at Asset Based Lending
Dealing with derivatives
Under Dodd-Frank, the riskiest derivatives, including credit default swaps, must be regulated by the Commodity Futures Trading Commission (CFTC) or the SEC. To assist them in becoming more transparent, a clearinghouse resembling the stock exchange will be established, which will allow derivative trading to be conducted publicly. In addition, the regulators will be able to determine the way in which this clearinghouse will be set up. However, some derivatives are not covered by the law, and the SEC and the CFTC also approved the exemption of some financial institutions, energy companies and hedge funds from derivative oversight.
Dodd-Frank's effect on insurance companies
The bill also created a Federal Insurance Office (FIO) within the Treasury Department to identify insurance companies creating risk to the entire industry, as AIG did. When the insurance company's business credit rating was downgraded and it became the center of a significant liquidity crisis, the Federal Reserve Bank found it necessary to intervene with an emergency fund consisting of $85 billion of taxpayer money to assist AIG in meeting its financial payments. The FIO has the task of compiling data related to the insurance industry and ensuring that minorities have access to affordable insurance. It also has the power to decertify agencies that are non-compliant.
The Consumer Financial Protection Bureau (CFPB) was created as part of Dodd-Frank, and it shields consumers from financial institutions' “unscrupulous business practices.” It has consolidated many consumer protection responsibilities that were previously fulfilled by other government agencies. In this capacity, the CFPB works with major financial institutions to prevent risky lending and other transactions that are harmful to consumers. The CFPB also gives consumers access to information concerning mortgages and credit scores as well as a toll-free 24-hour hotline for reporting problems with financial services. In addition, it monitors payday and consumer loans, credit and debit cards and credit reporting agencies.
To prevent insider trading and corruption, this bill also contains a provision dealing with whistle blowing, and anyone who has knowledge of security violations can provide the government with this information and receive a financial reward.
Fox News reports that the regulatory environment Dodd-Frank has created, along with the uncertainty arising from the many vague provisions it contains, is having a negative effect on small business lending. Small businesses can only succeed if they have access to capital, which is also needed for the nation's economic recovery. When this is lacking, they are unable to stay in business, and creating new jobs is unthinkable.
Along with that, Dodd-Frank has a disproportionate effect on small financial institutions, and small businesses rely on community banks and credits unions for their lending needs. When these funds are unavailable, many of them are forced to cease operations. In addition, small lending institutions are not in a position to hire the additional employees they would need in order to deal with the vast array of new regulations contained in Dodd-Frank. The increase in expenses related to the act will create a decrease in income, thereby reducing their ability to meet the business credit needs within their community.
On Wall Street, this act is viewed as “overkill” in regard to the recent recession that will overburden financial institutions, hinder economic growth, and prevent investors from filling their necessary role. Others see it as means of protecting investors, reducing unnecessary risk, and protecting consumers as well.
Some critics feel that these regulations are insufficient if the goal is to monitor Wall Street, which in their view is out of control, determined to take risks, and relying on bailouts with public tax dollars. Others maintain that if Dodd-Frank had become law sooner, the recession of 2008 might have been prevented. Many analysts are of the opinion that if Congress, regulators and the markets had abided by the rules in force at the time, that financial calamity might never have happened. While opinions may vary, the effect of Dodd-Frank on Wall Street will not be determined anytime soon.
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