As the United States prepared to take a long holiday over the July 4th weekend, the Department of Justice set off some fireworks of its own: the department published a new edition of the FCPA Resource Guide, a one-volume compendium of all things related to the Foreign Corrupt Practices Act (FCPA). What does the Foreign… Read More
What is the Dodd-Frank Act?
Passed in 2010 by the Obama administration as a direct response to the 2008 financial and housing crisis, the Dodd-Frank Wall Street Reform and Consumer Protection Act (known as the “Dodd-Frank Act”) contains numerous provisions aimed at increasing oversight of banks and protecting consumers from predatory mortgage lending practices.
What was the Purpose of the Dodd-Frank Act?
The purpose of the Dodd-Frank Act was to prevent a repeat of the 2008 financial crisis, sometimes called the Great Recession, during which American households lost over $16 trillion in net worth and nearly 9 million Americans lost jobs. This crisis was ultimately caused by deregulation in the financial industry, beginning with the Financial Services Modernization Act which allowed banks to sell over-the-counter financial derivatives, such as mortgage debt, to other institutions.
Banks would sell mortgage debt to hedge funds, who would bundle them into mortgage-backed securities, assign them a value, and sell them to investors. These securities were attractive to investors because the returns were good, the securities were backed by real estate, and they could be insured using credit default swaps.
This business model increased the demand for mortgages, incentivizing banks to approve large volumes of interest-only loans at subprime rates.
Eventually, however, the Federal Reserve started to raise interest rates. Between November 2002 and June 2006, interest rates increased from 1.25% to 5.25%. This made mortgage payments more expensive for many people who simply couldn’t afford to pay. Housing prices also began to fall in 2005, meaning that many homeowners could no longer pay off their mortgage by selling their home.
When homeowners defaulted on their mortgages, there were huge financial impacts for banks, hedge funds, insurance companies, and private investors—everyone involved in the creation and trade of mortgage-backed securities.
What Provisions are Included in the Dodd-Frank Act?
The Dodd-Frank Act introduced a number of changes to the American banking industry and financial regulatory system, including:
- Creating two new agencies, the Financial Stability Oversight Council and the Office of Financial Research to monitor systemic risk within the United States financial system.
- Expansion of federal liquidation and receivership laws to handle insurance companies and other financial companies.
- Permanently increasing the amount of deposits insured by the FDIC to $250,000.
- Requiring hedge fund and private equity fund managers to register as investment advisers.
- Creating the Federal Insurance Office and reforming state-based insurance.
- The Volcker rule, which restricts banks from engaging in large-scale speculative investments.
- Bringing credit derivatives and credit default swaps onto regulated exchanges.
- Increased protections for investors, new regulations for credit rating agencies, new rules for asset-backed securitization, corporate and executive accountability measures
- Creating the Bureau of Consumer Financial Protection.
- Enacting mortgage reform and creating minimum standards for mortgages to reduce predatory lending.
- Establishing a bounty program that encourages whistleblowers to report employers who violate financial regulations.
- Creating an Office of Credit Ratings at the SEC to ensure that agencies provide accurate credit ratings to their customers.
Is the Dodd-Frank Act Still in Effect?
The Dodd-Frank Act is still in effect, but was partially repealed in 2018 by the Economic Growth, Regulatory Relief and Consumer Protection Act.
This act raises the threshold for systemically important financial institutions from $50 billion to $250 billion in consolidated assets, a change which meant that dozens of large American banks would no longer be subject to the “Enhanced Supervision and Prudential Standards” described in Sections 165 and 166 of the Dodd-Frank Act.
The Volcker Rule has also been partially repealed—banks with under $10 billion in assets are now excluded from its purview and a new amendment passed in 2020 will narrow the scope of Dodd-Frank even further.
How Does the Dodd-Frank Act Relate to Corporate Compliance?
The Dodd-Frank Act created new corporate governance and regulatory requirements for North American banks, especially those who meet the definition of a systemically important financial institution. Especially important here is Title XIV, the Mortgage Reform and Anti-Predatory Lending Act, which establishes minimum standards and mandates the use of automated valuation models to estimate collateral value for mortgages. Financial institutions must adopt corporate governance policies and procedures to ensure oversight and universal compliance with Title XIV requirements, along with the many other regulations set forth by Dodd-Frank.