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Will we be safe from economic melt-down if Dodd-Frank is dismantled?

The Dodd-Frank Act is likely to come under fire from the Trump administration next year. What could be some of the consequences of this?

Gerard Hergenroeder, of IBM, argues in this blogpost on Finextra that “the repeal of Dodd-Frank will create a flurry of innovation in the US”. He says that 'banking leaders' will then be free to innovate on revenue-generating products, by shifting the resources they currently give to compliance (up to 50 per cent of IT budget, according to Hergenroeder) into these new innovative areas. Making the outlandish claim that “banking will become fun again”, Hergenroeder predicts that banks will rebuild their ageing infrastructure, helped by fintechs.

Banking fun?

So what kind of fun does Mr Hergenroeder envisage will return to banking? Is he referring to the kind of 'fun' that gave us the selling of sub-prime mortgages in the US in the years leading up to the 2008 collapse of Lehman Brothers? Some might say that banking is not meant to be fun and most would prefer a bank to behave responsibly and safely.

Do we need Dodd-Frank?

Just as a quick recap, Dodd-Frank – full name Dodd–Frank Wall Street Reform and Consumer Protection Act, 2010 – was designed to tackle the weaknesses in the US banking system that caused the banking crisis in 2007 and 2008 (and then spread to Europe necessitating huge bank bailouts). Although the final 2,300-page Act consisted of 16 titles, it had several overarching aims:

  • to consolidate regulatory agencies;
  • financial markets regulation, including increased transparency and of derivatives contracts;
  • measures for increased consumer protection;
  • enabling bankrupt firms to be wound down in an orderly way;
  • increased regulation of credit rating agencies and improved accounting practices; and
  • prohibiting depository banks from proprietary trading (the Volker rule, similar to the Glass-Steagall Act).

So do we need this Act? Does it not protect consumers and improve the stability in the financial system, preventing banks that are 'too big to fail'? This is the legislation's stated intent: “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”

Will consumers be protected?

One of the regulators created under Dodd-Frank that is likely to come under fire from the Trump administration is the Consumer Financial Protection Bureau (CFPB), which oversees protection of consumers in areas including home finance, student loans, credit cards and banking practices. According to the Financial Times, the CFPB is far from popular with banks and is likely to face “persistent political pressure”. However, dismantling consumer protection would go against the grain of Trump's populist “for the people” narrative. Nonetheless, US banks could be allowed to operate with less compliance, fewer KYC checks and fewer constraints on lending.

A mess and a bad law?

And there are many voices in the financial media who seem to be quite thrilled at the idea of a watered-down version of Dodd-Frank. Tim Worstall, writing in Forbes, says: “Dodd Frank is both a mess and bad law. Good grief, it even contains some ideas from Elizabeth Warren which is taking broadmindedness in the pursuit of public policy to unfathomable extremes. Repeal it, get rid of it.” Worstall advocates tackling the main problem as he sees it, which is the “too big to fail” banks through taxation, which he says has worked in the UK's bank levy.

However, while Trump's transition team have blamed the law for sluggish economic growth, there is the possibility that the slow growth of recent years can be traced back to the 2008 financial crisis, the causes of which Dodd-Frank was enacted to eliminate. Despite the transition team's claims that the law “doesn't work for the people”, there seem to be quite strong indicators that the effects of Dodd-Frank are primarily to protect us from financial wrong-doing and the risk of having to pick up the pieces (and the bill) following another financial disaster such as the 2008 bailouts.

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