This week marks the 15th anniversary of the Dodd-Frank Wall Street Reform Act, or Dodd-Frank for short. Following the 2007-2008 financial crisis, Congress mistakenly believed that the Great Recession was caused by lax government regulation in the financial sector. In response, Congress passed the 2,300-page behemoth with 400 new rules and mandates for federal regulators known as Dodd-Frank. It remains the largest and one of the most complex pieces of legislation in U.S. history. As the title of today's piece indicates, Dodd-Frank has been a dud in financial regulation.
Dodd-Frank failed its central mission. One of the main purposes of Dodd-Frank was to prevent another systemic banking crisis. However, the United States experienced another crisis in March 2023 that involved bank runs and emergency bailouts. As I detailed in my response to the March 2023 crisis, there were plenty of regulations in place to possibly prevent it. Rather, it was the inability of federal regulators to do their job of detecting the buildup of interest rate risk at several banks.
Increased moral hazard. The 2023 banking crisis is not surprising since Dodd-Frank's regulatory model encouraged banks to rely more on insured deposits instead of private market funding sources such as subordinated debt. With reduced market discipline, it disincentivized close monitoring of banks. The 2023 banking crisis is higher moral hazard, which in turn increases the likelihood of another banking crisis due to Dodd-Frank regulations.
Impact on smaller banks. Much as is the case with other regulations, Dodd-Frank has disproportionately affected smaller banks. There were 157 major final rules and programs from Dodd-Frank that affected smaller banks. This creates a significant compliance challenge since smaller banks often have limited staff and expertise to handle the additional compliance. As a 2020 study from the Federal Deposit Insurance Corporation (FDIC) shows, these regulations contributed to a higher exit rate of smaller community banks (see below); a larger minimum size that discourages new community bank formation; and reduce their residential mortgage holdings, which is a major source of revenue for smaller banks.
Debit card fees. The Durbin Amendment of Dodd-Frank capped interchange fees on debit card transactions. As the Americans for Tax Reform argues, this price control cuts off revenue for fraud protection; hurt consumers with rising account fees and fewer rewards programs; and did not deliver on the promises to lower prices. I made a similar argument when criticizing Congresswoman Ocasio-Cortez's argument for interest rate caps. After reviewing the academic literature, it turns out that the Durbin Amendment led to higher ban fees, increased reliance on costly credit cards, and caused one million Americans to become unbanked.
Increased lending costs harm consumers. Another amendment of Dodd-Frank is the Collins Amendment. The Collins Amendment imposed strict capital and leverage requirements, especially when combined with Basel III standards. As the Institute for Financial Markets points out, these strict capital requirements increase lending costs. Why? Banks need to raise more capital to meet these capital requirements. As a result, the most likely outcome of high capital requirements such as those in Dodd-Frank is that consumers pay higher interest rates or fees (FDIC). These capital requirements also make more difficult for borrowers to qualify for loans or afford them, thereby limiting financial tools to the everyday American.
Consumer Financial Protection Bureau (CFPB) harms consumers. To protect U.S. consumers from risky financial decisions, Dodd-Frank included a provision to create the CFPB. The CFPB is supposed to be responsible for regulatory oversight over consumer financial products. However, as I brought up this past February, CFPB has been a disaster that needs to be eliminated. Forget that the CFPB duplicates the roles of existing state and federal regulators. CFPB policies, especially fee caps and credit reporting restrictions, distort market incentives, restrict access to mainstream financial services, and push vulnerable individuals toward riskier alternative financial options. Furthermore, CFPB lacks accountability, operates without adequate oversight, and implements ideologically driven regulations that do nothing to protect the everyday consumer.
Postscript. Given the sheer size of Dodd-Frank, there is plenty more I could cover, including, but not limited to, the Volcker Rule, Orderly Liquidation Authority (OLA), and the the Federal Insurance Office within the U.S. Treasury. What I will say is the following. While Dodd-Frank was meant to avoid another financial crisis and maintain stability in the financial markets, it has been riddled with failure and unintended consequences.
The regulatory framework not only was inadequate to prevent the 2023 banking crisis, but it increased moral hazard, harmed smaller banks, and increased consumer costs for financial services. Dodd-Frank has been more of a hindrance to the financial markets than a help. With its complexity, inefficiency, and lack of accountability, the 15th anniversary of Dodd-Frank should be spent repealing this dud, not celebrating it.
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