Introduction
The Dodd-Frank Act of 2010 refers to a financial regulation law that was enacted after the great recession of 2008. It is also referred to as the Dodd-Frank Wall Street Reform and Consumer Protection Act (Anand, 2011, p.78). The main aim of the law is to regulate the major players in the financial markets to manage the effects of the great recession of 2008 as well as eliminate the possibility of a recurrence. In addition, it aims at preventing a recurrence of the collapse of major financial institutions, which had adverse effects on the economy of the United States. The Dodd-Frank Act also protects consumers from suffering the effects of bad decisions by financial institutions (Anand, 2011, p.81). The bill contains many rules of regulation that are meant to avert a recurrence of the great recession. The bill has many pros and cons, which depend largely on the success of its implementation.
Pros of the Dodd-Frank Act
The act has many benefits that protect consumers and financial institutions from bad financial decisions. First, the Dodd-Frank act contains a provision that subjects financial institutions to regulations that ensure that they do not make decisions that sabotage their financial stability (Acharya Richardson, 2012, p.5). In addition, any financial institution may be broken up if the regulators find proof that the institution is on the verge of fall. The Financial Stability Oversight Council is responsible for evaluating financial institutions and markets to determine if there are any risks that may affect the financial markets. The council is headed by the secretary to the treasury and comprises nine members. In addition to overseeing financial institutions, it also oversees non-financial institutions such as the hedge fund firms. If the council determines that a bank is too big and does not serve its customers effectively, it may be required to increase its reserve funds. These measures are aimed at preventing the collapse of banks as well as protecting consumers who may suffer from such collapse (Acharya Richardson, 2012, p.7).
Secondly, the Consumer Financial Protection Agency (CFPA) protects homeowners by requiring them to understand the full details of mortgages before purchasing them (Acharya Richardson, 2012, p.9). This is in an attempt to keep homeowners away from risky mortgages. In addition, it requires banks and other lending financial institutions to have the full details of a borrower’s income, job status and credit history in order to avoid issuing bad loans. The CFPA manages agencies involved in credit reporting, consumer loans and credit and debit cards transactions.
Thirdly, the Volcker Rule protects banks from misappropriating customer funds. It prevents financial institutions from either using or possessing hedge funds for their own financial gains (Acharya Richardson, 2012, p.15). This is because banks usually use depositors’ money to make financial gains in other areas of the economy. The Dodd- Frank Act gave banks a period of 7 years to determine which funds are to be used for the banks’ profits and which funds belong to customers. It allows banks to retain funds that are less than 3% of the total revenue accrued. The Volker Rule protects customers because it prevents banks from gambling with their money in investing in risky business ventures (Acharya Richardson, 2012, p.16).
Fourthly, the Dodd- Frank Act regulates risky derivatives so that decisions that are highly risky and that may expose the institutions to financial crisis may be identified and averted. The Commodity Futures Trading Commission (CFTC) conducts this survey and identifies risky decisions. The act requires the establishment of a clearinghouse that ensures that the derivatives are publicly traded to prevent dubious transactions by banks (Acharya Richardson, 2012, p.19).
Fifthly, the act contains provisions that make the trade of hedge funds transparent. Lack of regulation of hedge funds was one of the major causes of the 2008 financial crisis. As such, information on what the hedge funds were investing in, and the amount they were investing was not available to the public. The Dodd- Frank Act requires all hedge funds to register with the SEC and provide all the necessary information about their trades (U.S. Securities and Exchange Commission, 2012, par4). In addition, the act gives the state power to regulate investment advisers because it raised the asset threshold required to $100 million.
Lastly, the Dodd-Frank Act contains provisions that are aimed at reforming the Federal Reserve. Under the act, the Government Accountability Office (GAO) is mandated to audit the emergency loans of the Federal Reserve during a financial crisis. This means that the Fed has to get the approval of the Treasury Department before issuing any emergency loans to any financial institution. In addition, the Federal Reserve is also expected to announce publicly the names of the banks that received emergency loans during the crisis (U.S. Securities and Exchange Commission, 2012, par8).
Cons of the Dodd- Frank Act
Despite its many benefits, the Dodd-Frank Act has several disadvantages that have potential adverse effects on the economy. First, the Dodd-Frank Act gives excess regulatory power to the Federal Reserve. This may have adverse effects on financial institutions because powerful institutions may manipulate the Fed to have their way. Secondly, the bill contains effective regulatory principles, but gives the power to draft rules to implement these principles to regulatory agencies (Wallison, 2010, par4). It is ironical because these are the same regulators that failed to prevent the 2008 financial crisis from happening. In addition, the Byzantine rulemaking process has in the past led to disagreements among regulators. This may lead to rules that may not be effective in regulating financial institutions. In addition, the different affiliations of the regulators are an obstacle to the proper implementation of the bill. Regulators affiliated to the republicans have a feeling that the implementation of the bill is too fast while those affiliated to the democrats feel that the implementation of the bill is too slow (Wallison, 2010, par4). Thirdly, the regulations of the bill help big banks at the expense of small banks and financial institutions. It has led to low lending rates among the small banks and high lending rates by the big banks. The low rates of lending have exposed small businesses to tough times and low growth rates (Wallison, 2010, par6).
The implementation of the bill is so far positive. For example, the Consumer Financial Protection Bureau has been developed and its main role is to protect consumers from investing in financial derivatives and assets that they do not fully understand. In addition, rules have been established that will govern the provisions of the act that give shareholders power to engage in deciding the pay of executives, and a program that is meant to reward whistle-blowers. Even though the implementation of the bill is slow, the world is responding positively to the bill.
Conclusion
The Dodd-Frank Act of 2010 refers to a financial regulation law that was enacted after the great recession of 2008. It is also referred to as the Dodd-Frank Wall Street Reform and Consumer Protection Act. The main aim of the law is to regulate the major players in the financial markets to manage the effects of the great recession of 2008 as well as eliminate the possibility of a recurrence. In addition, it aims at preventing the collapse of major financial institutions, which had adverse effects on the economy of the United States. The world is reacting positively to the implementation of the bill. However, due to the complexity and ambiguity of some parts of the bill, the implementation process is slow.
References
Acharya, V., and Richardson, M. (2012). Implications of the Dodd-Frank Act. Financial Economics, 4, 1-38. Web.
Anand, S. (2011). Essentials of the Dodd-Frank Act. New York: John Wiley & Sons.
U.S. Securities and Exchange Commission. (2012). Dodd-Frank Wall Street Reform and Consumer Protection Act. Web.
Wallison, P. (2010). The Dodd-Frank Act: Creative Destruction, Destroyed. Web.