Factsheet on Dodd-Frank Act

This fact sheet aims to provide an overview on the Dodd-Frank Act by firstly explaining its background, intention and content and secondly outlining its implications on the US financial institutions by summarising some main arguments in favour as well as against the DoddFrank act.

Background The lack of accountability in the financial system is said to be one of the major causes for the recent financial crisis from 2007 until 2010. The regulatory system therefore thrust onto centre stage and became subject to widespread revision. As a result, US President Barack Obama has signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law in July 2010. This legislation reshaped the US regulatory environment in a way which has not been seen since the aftermath of the Great Depression.

(http://www.mofo.com/files/Uploads/Images/SummaryDoddFrankAct.pdf

Intention & Content The main purpose of the legislation is to grant financial stability in the US and to ward off a potential repetition of the events endured during the recent financial crisis by adjusting the shortcomings that those events have revealed. The legislations stated aim is the following: 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. (http://www.gpo.gov/fdsys/pkg/PLAW-111publ203/pdf/PLAW-111publ203.pdf) The legislation is of a substantial extent and is divided into sixteen titles covering a wide range of areas including the following:

Consumer Protection Introduction of an independent authority called The Consumer Financial Protection Bureau which aims to provide US consumers with clear and non-misleading information regarding financial products (i.e. mortgages, credit cards)

Too big to fail bailouts In order to prevent further bailouts financial institutions should be reduced in size and incentivised to take on less risk by implementing tougher capital requirements. Furthermore, a feasible way of liquidating failed institutions has to be found. A topic of particular interest is the Volcker rule which prohibits propriety trading for banks.

Transparency and accountability with regard to derivatives These provisions aim to increase transparency in derivates by reducing OTC-trading (over-the-counter) through the introduction of central clearing and exchange trading. The remaining OTC-business will be subject to more extensive standards of conduct.

Compensation and Corporate Governance Corporate Governance shall be reinforced in order to reduce asymmetric information between shareholders and managers. In particular, shareholders should be given the right to vote on management compensation and golden parachutes.

Investor protection Rating agencies will be under stronger surveillance from independent authorities to prevent conflicts of interest and will be held responsible for violating their due diligence duties.

(http://banking.senate.gov/public/_files/070110_Dodd_Frank_Wall_Street_Reform_co mprehensive_summary_Final.pdf)

Critical Voices Not many financial institution representatives talk publicly about the new regulations. This is mainly due to fears that their already tarnished images might suffer even further if they object financial regulation in the aftermath of the crisis. However, most are to say the least, very concerned. Two articles of The Economist (February 18th, 2012) outline some of the reasons:

The bureaucratic requirements of the new apparatus consisting of already existing and new regulating institutions (see diagram) are

thought to be extremely expensive to put into practice. E.g. the

completion of a new form that mainly Hedge Funds will be asked to fill out is expected to cost between USD 100,000 and USD 150,000 the first time and around USD 40,000 in the years after. JPMorgan Chase believes the overall annual direct costs of Dodd-Frank for the bank will be between USD 400 and USD 600 million.

The mere size of the law gives rise to doubts. Currently it consists of 848 pages addressed to lawmakers which in turn, are encouraged to further develop it. An example is a rule aimed at bank's proprietary trading which evolved from 11 pages of the Dodd-Frank into the 298-page Volcker Rule. Experts fear that such complex and detailed regulation will inevitably cause constant disputes and lawsuits for years to come, leading to a vast amount of ever more detailed exceptions. The complexity of the law is believed to hamper innovation within the financial sector and therefore endanger the US economy as a whole.

Acknowledging that tighter regulation for some parts of the financial system are needed, especially the ones most affected by the crisis, The Economist writes that Dodd-Frank misses out on the chance to address some of the most important problems like the ones in connection with America's largest lenders Fannie Mae and Freddie Mac. These had to be bailed-out in 2008 and have since then become even more important. On the other hand, Dodd-Frank has an impact for example on manufacturers extracting minerals from the Congo, including costs of USD 9 to USD 16 billion (estimate by The National Association of Manufacturers) for the whole sector. Obviously, these producers did neither kick-off nor add to the financial crisis. Nonetheless, they will be affected heavily by a regulation that is intended to prevent future disasters in another part of the economy.

Looking at the complete picture, it is questionable whether the benefits of Dodd-Frank outweigh its costs which are burdening the financial sector with bureaucracy, complexity and uncertainty that would obstruct not only banks, but the whole US economy.

Defending Dodd-Frank In response to the concerns pointed out by The Economist, various officials of US agencies and even former senator Christopher Dodd and Barney Frank, former Chairman of The House Financial Services Committee, who jointly gave the act its name, wrote letters in defence of Dodd-Frank. They highlight that drafting the rules, their aim was to prevent Americans from losing their houses and jobs in future crises and to make investors bear the costs of high risk taking and not the taxpayers. In contrast to the critics the proponents believe that the benefits of the new rules justify the costs incurred. These benefits include a fundamental change in capital requirements for financial institutions which has already taken place. Further achievements credited to Dodd-Frank so far are a new way of bankruptcy to unwind large banks in case they get into troubles and a consumer that is better protected than before the crisis.

Sources http://www.mofo.com/files/Uploads/Images/SummaryDoddFrankAct.pdf http://banking.senate.gov/public/_files/070110_Dodd_Frank_Wall_Street_Reform_comprehe nsive_summary_Final.pdf http://www.gpo.gov/fdsys/pkg/PLAW-111publ203/pdf/PLAW-111publ203.pdf The Economist, February 18th, 2012