July 21st was a big day in the financial regulation world: the Dodd-Frank Wall Street Reform and Consumer Protection Act turned 1 year old, and a number of its provisions kicked in. Hailed as the most sweeping financial reform since the Great Depression, Dodd-Frank is nonetheless a highly contentious bit of legislation. Two provisions, the Durbin Amendment and the creation of the Consumer Financial Protection Bureau, drew most of the flak, though the law contained 16 provisions in all that required regulators to institute 243 rules, conduct 67 studies and make 22 reports.
The birth of Dodd-Frank
The bill was written as a response to the financial crisis that began in 2007 to prevent another “too big to fail” scenario, increase transparency and accountability, and better protect and inform consumers. The bill did not include the Volcker Rule, a provision dear to President Obama. The rule would have prohibited depository banks from trading stocks, bonds, derivatives and the like. It was modeled on the Glass-Steagall Act of 1933, which was repealed in 1999 with bipartisan support. The Volcker rule passed a Senate vote, but didn’t survive the Senate-House reconciliation.
The bill did include a last-minute addition that’s drawn more controversy than nearly any other provision: the so-called Durbin Amendment, which drew criticism because it wasn’t debated. The final version of Dodd-Frank passed largely along party lines and was signed into law on July 21st, 2010.
Key provisions: consumer protection, Durbin and mortgages
Title X: Bureau of Consumer Protection: Dodd-Frank created the Consumer Financial Protection Bureau, which is housed within the Federal Reserve. It is charged with regulating financial products such as mortgages and credit cards. Among the bureau’s proposals are a requirement that banks offer a “plain vanilla” mortgage that is easy to understand and a comprehensive report on the Credit CARD Act of 2009 and its effect on the credit card market.
The bureau officially opened its doors on July 21st of 2011, but as yet has no director. The woman responsible for dreaming and creating the bureau, Elizabeth Warren, was deemed too controversial to survive a Senate confirmation. In her place, President Obama nominated former Ohio attorney general Richard Cordray. However, Senate Republicans have vowed to block any and all nominations unless the board’s single directorship is replaced with a five-member committee. For more, please read:
- An explanation of the Consumer Financial Protection Bureau
- Coverage of House hearings and bills that would change the bureau’s structure
Title X, Section 1075: The Durbin Amendment is tucked into the section that mandated the CFPB into existence, and requires the Federal Reserve to cap debit swipe fees at reasonable rates. On June 29th of this year, the Fed issued its final ruling on interchange fees: the charges would be capped at 21 cents plus 0.05% of the transaction, with the possibility to charge an additional cent. The average $38 debit transaction would now have a maximum 24-cent interchange fee, down from 44 cents. We’ve covered the Durbin Amendment extensively in other articles. For a more in-depth look, please read:
- A detailed description of the Durbin Amendment
- Senator Jon Tester’s challenge to the amendment
- The Fed’s final ruling and the ensuing reactions
Title XIV: Mortgage Reform and Anti-Predatory Lending Act: This provision endeavors to prevent the aggressive lending to subprime borrowers that characterized the mid-2000’s housing market. It puts the onus on lenders to ensure that borrowers are creditworthy, requiring income verification for mortgages and banning prepayment penalties. It also banned yield-spread premium bonuses. A yield-spread premium is the extra money that a borrower ends up paying, usually because he is encouraged to do so by a broker. For example, if a buyer takes out a $200,000 subprime loan and ends up paying $10,000 more over four years than he qualifies for, the broker would receive $4,000. YSP bonuses give brokers a percentage of the premium, and some argue that it creates an incentive to cheat consumers out of the best rates. In addition, the act required that banks and any other institutions that issue mortgage-backed securities keep at least a 5% piece of the loans they sell. This is meant to incentivize lenders to make responsible lending decisions.
One year later, where do we stand?
Some of the provisions of Dodd-Frank have dominated the news, mainly Durbin and the CFPB. Others have quietly gone into effect, while still more have been delayed or seen their funding cut off by a hostile Congress.
Securities regulation: Many provisions of Dodd-Frank dealt with the derivatives market, or trading based not on stocks but on aspects of the stocks. Derivatives come in many forms, but can be characterized as hedges or bets. A farmer, for example, can promise to sell his crops for a certain price to protect against a drastic price fall. Agricultural derivatives have existed for decades and allow farmers, who are particularly vulnerable to unexpected conditions, to guarantee at least some income. Newer derivative products are speculative, or “bets,” and allow a trader to, for example, bet that Microsoft’s stock will fall in the next three months. Dodd-Frank required the Commodity Futures Trading Commission to regulate the derivatives market, which has for the most part operated without oversight. But the CFTC, citing budget constraints, will put off introducing its rules for six months. The Securities and Exchange Commission is in a similar bind: it is unable to fulfill its current role with a strained budget, let alone assume the greater authority prescribed by Dodd-Frank.
Durbin Amendment: The Durbin Amendent’s interchange fee cap was scheduled to be implemented on July 21st, but the Federal Reserve missed several deadlines in announcing its proposals. On June 29th, it finally announced the 24-cent (average) fee cap. Banks had more or less already factored interchange fee losses into their business models, and cut back on debit rewards and free checking (though those accounts still exist). Merchants are likely to see the greatest benefit, according to Fed chairman Ben Bernanke, and only time will tell what if anything consumers will gain.
Consumer Financial Protection Bureau: While President Obama put Mr. Cordray’s name up for director of the CFPB, the Senate has yet to hold a confirmation hearing. The bureau opened its doors on schedule on July 21st, but without an executive at the helm. Its existence is being challenged by Senate Republicans, who have taken a strong stance against both it and its acting director, Elizabeth Warren. But even though fiscally conservative politicians are staunchly opposed, many banks have expressed cautious approval and Moody’s argued that better regulation could actually help the financial industry. Polls show that most Americans approve of the bureau. For now, the bureau languishes, legally prohibited from assuming its full role without a director.
Other provisions: Other parts of the law have taken effect. For example, a consumer who is denied a loan or offered less-than-ideal terms is now entitled to know his credit score. And, as we mentioned, yield-spread premium bonuses are now prohibited. Other provisions are still hotly debated, such as one that holds “systemically important” financial institutions to greater capital requirements.