Head-to-head: is Dodd-Frank working?

Author: | Published: 28 Jun 2017
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Q: Is Dodd-Frank working?


Dennis M Kelleher, president and CEO, Better Markets

In late 2008, the nation's financial system teetered on the brink of collapse, brought there by the worst financial crisis since the Great Crash of 1929. The economic wreckage that followed was the worst the country had experienced since the Great Depression. Indeed, the Great Recession, as it has come to be known, will end up costing the country more than $20 trillion in bailouts, lost jobs, foreclosed homes, drained retirement savings, and more. In response, Congress passed and President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act, which overhauled or enhanced virtually every aspect of America's financial protection rules: banking, securities, commodities, derivatives, and consumer protection. Critics of Dodd-Frank like to say the law was not needed, that it hasn't worked, and that it has stifled lending and economic growth. The evidence is indisputable: these claims are wrong.

Following the 1929 crash, the country passed laws and regulations to create layers of protection between Wall Street's activities and Main Street's livelihoods. Those reforms imposed the heaviest regulation on the financial sector in the history of the world. Yet, America enjoyed a booming economy in the ensuing decades, the financial industry thrived, and the country prospered and created the largest middle class ever. But the era of deregulation in the 1990s ushered in recklessness, unrestrained risk taking, and illegal and even criminal activity that directly contributed to the 2008 financial crash. The resulting crisis exposed numerous weaknesses and flaws that had developed in nearly every level of the financial system. It further revealed that the regulatory system which to that point had been adequate to oversee the simpler financial system of the 20th century was incapable of monitoring the more complex and interconnected 21st century financial system.

There can be no doubt that Dodd-Frank will help reduce the likelihood of another financial crisis or lessen its severity

A look at the changes since Dodd-Frank was enacted offers further proof. The biggest banks, or systemically important financial institutions (Sifis), have doubled their capital to better withstand losses without failing or turning to taxpayers or the Fed for a bailout. They have much better liquidity than before the crash to meet demands for cash without having to hold a fire sale of assets to pay creditors. The Sifis are clearing many of their derivatives trades through central clearing houses to mitigate the risk of any one Sifi building up an unknown, unmanageable exposure. Because of the Volcker Rule, Sifis can no longer make high-risk proprietary bets with taxpayer-backed deposits. Rigorous stress testing ensures Sifis have the resilience to withstand unforeseen economic shocks. And living wills have forced Sifis to demonstrate that they can be wound down in bankruptcy without requiring government bailouts or jeopardising the financial system.

It can't be denied that Dodd-Frank has made us safer and that financial reform is working. But what of the claim that the law has hurt banks and lending? According to recent FDIC data, banks are more profitable than ever. Consumer credit has roared back since the law was passed in 2010 with a 46% jump in outstanding consumer credit to $3.8 trillion. Mortgage, auto and credit card lending have all gone up in the past seven years. Further, as European banks including Deutsche Bank, Monte dei Paschi, and others have come close to failure, it is noteworthy that the danger did not spread to US banks, which likely would have been the case without the protections required by Dodd-Frank.

What accounts for the difference? The Dodd Frank Act required comprehensive action to stabilise the financial system, as emphasised by National Economic Council chairman Gary Cohn, who spoke to Bloomberg TV in 2016 when he was serving as President of Goldman Sachs: "Almost all US banks took our medicine [recapitalising, restructuring and implementing financial reform rules] early….We really built our balance sheet up. We really de-leveraged ourselves. We really built enormous excess liquidity….And we made ourselves as financially secure as we could."

There can be no doubt that the Dodd-Frank Act is working as intended, and that it will help reduce the likelihood of another financial crisis or lessen its severity.

Contrary to the self-serving but baseless sky-is-falling predictions from industry, banks have thrived under the law, and economic growth has risen. Unless the industry and its political allies are successful in rolling back these key protections, we can expect the Dodd-Frank Act to continue to promote the stability and integrity of the financial markets; protect consumers and investors; and support economic growth, employment, and broad-based prosperity.

Eyes on the prize: former president Barack Obama signs Dodd-Frank into law


Peter J. Wallison, senior fellow, American Enterprise Institute

The Dodd-Frank Act, based on the idea that the 2008 financial crisis was caused by insufficient regulation of the US financial system, is by far the most restrictive regulatory legislation imposed on the US financial system since the New Deal.

Many in Congress and elsewhere believe not only that the Act's restrictions are responsible for the unprecedentedly slow recovery of the US economy since 2008, but also that Congress failed to properly investigate and understand the real causes of the crisis. The act, then, in this view, is illegitimate. Accordingly, whether it should be comprehensively reformed - as the House of Representatives recently did in adopting the Financial CHOICE Act - or left essentially unchanged as its supporters believe, depends crucially on whether it was a valid response to the real causes of the financial crisis.

Indeed, there is strong evidence that Congress acted precipitately, without any significant investigation of other causes of the crisis. In 2009, before any legislative action began in Congress, the chairman of the House Financial Services Committee, Barney Frank, announced that Congress would enact 'a new New Deal'. He was as good as his word, driving a massive 2,300-page bill to completion in less than 18 months.

If Frank and Congress had been willing to look at alternatives, there would have been a lot to investigate. A fair analysis would have shown that it was the US government's housing policies - policies strongly supported over many years by chairman Frank himself - that were the cause of the financial crisis.

In 1992, for example, Congress enacted the Affordable Housing Goals, which imposed on Fannie Mae and Freddie Mac - two government-backed mortgage companies that dominated the US mortgage market - a set of quotas on the mortgages they acquired. Fannie and Freddie did not make loans; they bought them from banks and other originators and thus provided liquidity to the mortgage market. Initially, the goals required that 30% of all mortgages Fannie and Freddie acquired had to be made to borrowers at or below the median income where they lived.

If Mr. Frank and Congress had been willing to look at alternatives, there would have been a lot to investigate

The US Department of Housing and Urban Development was given authority to increase the goals, and beginning in 1996 it began to do so, aggressively. By 2000, the goals had been raised to 50%, and by 2008 to 56%. In other words, by 2008, more than half of all mortgages acquired by Fannie and Freddie had to be made to borrowers at or below median income.

To meet these goals, Fannie and Freddie, which prior to 1992 had always acquired only mortgages, made to borrowers with 10-20% down-payments and good credit records - had to reduce their underwriting standards. By 1997, they were acquiring mortgages with only three percent down-payments and by 2000 zero down-payments.

Because they were the dominant players in the US mortgage markets, when Fannie and Freddie reduced their underwriting standards others followed. This set off a massive 10-year housing price bubble, the largest in US history, between 1997 and 2007.

It is easy to see why this would happen. If underwriting standards require a 10% down-payment, a buyer with $10,000 can buy a $100,000 home, borrowing $90,000. But if underwriting standards decline to five percent, he can borrow $190,000 and acquire a $200,000 home. This process put strong upward pressure on housing prices and created many risky borrowers among those who stretched to buy larger and more expensive homes.

By 2007, housing prices were so high that no amount of concessionary lending would enable buyers to afford them, and the bubble began to deflate. At that point, more than half of all mortgages in the US were subprime, and 76% of those mortgages were on the books of government agencies, principally Fannie and Freddie. This shows, without question that the government created the demand for those mortgages.

In the housing price decline that followed, Fannie and Freddie became insolvent, and were taken over by the government. Many other financial firms also failed.

Congress never bothered to look at this explanation of the 2008 financial crisis. If they had, and had done it fairly, they would have reformed the US housing finance system instead of enacting the destructive Dodd-Frank Act.




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