Tuesday, 28 May 2024

At odds with Dodd-Frank

5 min read

By Tanya Angerer

In a matter of weeks US President Donald Trump’s administration will lay bare how they wish to regulate banks and markets. After months of scathing remarks about the Dodd-Frank Act, any clarity on exactly how Trump wishes to overhaul the system is welcomed by both detractors and supporters. But how much change should be expected?

  • Treasury Secretary Steve Mnuchin will present his findings on how to regulate banks and markets in early June
  • "On net, Dodd-Frank represented a positive step in lessening the risk in our financial system," reads an NYU Stern white paper 
  • While a broad overhaul of the Dodd-Frank Act is probably out of reach, many support simplifying the current rules and giving smaller banks more relief

Since being given 120 days to mull over the current regulatory system, US Treasury Secretary Steve Mnuchin is expected to present his findings in early June. His goal, according to the executive order, is to look over existing laws, ensuring they promote seven broad principles including empowering Americans and preventing taxpayer-funded bailouts.

Yet, die-hard critics of the current regulatory system, keen to hear the death knell of the Dodd-Frank Act, should not hold their breath, says Barney Frank, an ex-congressman of the United States and one of the act’s chief architects.

"There is no chance that Trump would get 60 votes through the US Senate, which is what you need to change a bill like this,’’ said Frank. "I have spoken to Democrats in the Senate and I don’t know anyone who would vote for a major weakening of the bill."

With 52 Republican senators currently, Trump would need at least eight or even nine Democratic senators to sway the vote, as Republican Senator Susan Collins from Maine, was one of three Republican senators who originally voted for the Dodd-Frank Act in 2010.

Missed opportunities

While a broad overhaul may be out of reach, there are many in both parties who would agree that certain rules need to be modified.

"Dodd-Frank missed an opportunity to streamline the US regulatory structure," said Justin Schardin, fellow at the Bipartisan Policy Centre. "We have three different federal prudential regulators and two different capital markets regulators. That’s led to duplication and gaps, which Congress should address somehow."

Even Frank, who lends his name to the bill, would be keen to relax the lending rules for smaller banks, with under $10 billion in assets, and push up the threshold for qualifying as a systemically important financial institution (SIFI).

"We are not looking to throw out the entirety of Dodd-Frank or other rules," wrote Jamie Dimon, JPMorgan’s CEO, in his April 2017 letter to shareholders. "It is, however, appropriate to open up the rulebook in the light of day and rework the rules and regulations that don’t work well or are unnecessary."

A few examples of the overbearing complexity in the system, that Dimon points to, are the multiple calculations of capital and the Volcker Rule, which prevents banks from proprietary trading. Also, Dimon flags that the multiple regulators involved leads to slow rule-making and excessive reporting.

With regards specifically to the Volcker rule, Citi chief financial officer John Gerspach said in the bank’s first quarter 2017 fixed income investor review that: ‘’We absolutely support the fact that banks should not be involved in proprietary trading."

"However, I don’t think that the current construct of requiring so many different analyses to prove that we’re not involved in proprietary trading is necessarily cost effective."

Aside from the executive order, which does not name Dodd-Frank explicitly, Trump has taken a direct punt at the act through several memorandums in April. The administration paused the Financial Stability Oversight Council’s (FSOC) ability to designate any further non-bank institutions as SIFIs while they review the council’s processes.

Since it was created, FSOC has faced some controversy over its SIFI labels. MetLife, the largest US life insurer, sued the FSOC to overturn its SIFI classification and in March 2016, a district court judge ruled in the company’s favour. The committee is appealing that decision.

"FSOC is a good idea but needs to be modified to be more effective," continues Dimon in the letter. FSOC "should be given some authority to assign responsibility, adjudicate agreements, set deadlines and force the resolution of critical issues."

Another of Trump’s memorandums calls for a check into whether the Orderly Liquidation Act (OLA), a back-up bankruptcy authority, may in fact increase excessive risk-taking rather than protect the system. The OLA, through the Treasury Secretary, has the authority to place a company in receivership if its failure carries systemic risks and bankruptcy proceedings fail.

The Institute of International Finance, with 500 members from 70 countries, called the OLA, also known as Title II of Dodd-Frank as "an essential component of the post-crisis regulatory regime".

"If Title II were to be repealed, the ability of foreign authorities to count on well-coordinated resolution planning with US authorities would be destroyed," wrote Timothy Adams, president and CEO of the IIF, in a letter to Mnuchin last month.


The alternative that some Republicans are touting to Dodd-Frank is the Financial CHOICE Act. The legislation, introduced by Texas Congressman Jeb Hensarling, got voted through the House Financial Services Committee, 34-26, along party lines, this month.

The comprehensive 500+ page proposal would, among other things, repeal the power of FSOC to designate SIFI firms; cancel the OLA and provide an “off-ramp” for banks that meet a certain average leverage ratio to get relief from other restrictions.

A NYU Stern white paper pitting the CHOICE Act versus Dodd-Frank published in March came to the conclusion that while Dodd-Frank has it shortcomings, the CHOICE Act may be ignorant of the risks in the system. 

"On net, Dodd-Frank represented a positive step in lessening the risk in our financial system," the paper reads. "But at the end of the day, the CHOICE Act is fatally flawed by a failure to recognise systemic risk and to understand the dangers that it poses for the financial system—and thus for the healthy functioning of the US economy."

Yet Schardin at the Bipartisan Policy Centre thinks it’s highly unlikely to pass the Senate.

"The CHOICE Act does include bankruptcy reform but eliminates the Title II Orderly Liquidation Act so we don’t agree with that,’’ Schardin continues. ‘’It is a comprehensive replacement – they put a lot of effort into it if nothing else."

What is clear is that without bipartisan support, Trump’s administration is likely to steer policy through the regulators rather than through Congress. Yet, there are more than ten positions at the financial regulatory agencies that Trump has yet to fill, including three federal governors.

"If Trump moves expeditiously, his nominees will have control by early 2018 at most of these agencies," says Schardin.

There seems to be widespread bipartisan support for simplifying the current rules and giving smaller banks more relief from the Dodd-Frank Act. Ultimately, it would be a missed opportunity for Trump’s administration to ignore these unintended consequences.

"The process should be as de-politicised as possible," writes Dimon. "Everyone stands to gain when growth is enabled in a safe and sound manner." 


Keywords: Dodd-Frank, SIFI, Volcker Rule, OLA, Choice Act
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