Broadly, Dodd-Frank seeks to strengthen financial market performance by (a) improving financial institutions' accountability and transparency, (b) protecting taxpayers from being saddled with future bailouts, and (c) protecting consumers from a plethora of abusive practices. In pursuit of these goals, Dodd-Frank does at least five major things.
A. First — Dodd-Frank seeks to limit the risk posed by existing financial institutions and by contemporary financial activities. Regarding the risk stemming from financial institutions, Dodd-Frank creates a new Financial Stability Oversight Council (FSOC) to monitor activities posting a systemic risk to U.S. financial stability. The FSOC is made up of the heads of a number of regulators (Fed, FDIC, SEC, etc.) that, it is envisioned, will coordinate the planning and assessment.
1. The FSOC will first attempt to prevent big institutions from failing. It has authority to provide greater oversight of those firms than has existed in the past and can require that they hold extra reserves that would not be required of other financial institutions. It also has authority to order liquidation of such firms in an orderly fashion if they do happen to fail. The Federal Reserve would carry out that process.
2. What sort of a firm is “too-big-to-fail?” Dodd-Frank focuses on bank holding companies that have at least $50 billion in assets and nonbank financial institutions (insurance holding companies, investment banks, etc.) that are systemically important. As authorities attempt to flesh out the specifics of these rules, unprecedented lobbying is occurring as interested parties attempt to shape the law to their own benefit. Because Dodd-Frank left so many rules unspecified, post-legislation lobbying is probably more critical for Dodd-Frank than any other statute in modern memory.
B. Second — Regarding risk deriving from modern financial practices, Dodd-Frank places limitations on proprietary trading by banks and their support of hedge funds (the “Volcker rule”). These limitations are to be phased in over the next few years. It is unlikely that the SEC will get all the rules rolled out without creation of a number of loopholes.
C. Third — Dodd-Frank requires increased transparency in the over-the-counter (OTC) markets. Abuse of derivative securities, such as credit default swaps, was arguably at the core of the financial meltdown of 2008. Dodd-Frank seeks to reduce the likelihood of a repeat of these abuses by, among other things, requiring that all “standard” derivatives be traded and cleared via clearinghouses, so that prices are more transparent. (The first such electronic trade occurred in late November 2010.) Dodd-Frank also requires that the clearinghouses not be controlled by the big banks and requires traders to put up “adequate” capital against losses they might sustain. Due to heavy lobbying, loopholes again abound.
D. Fourth — Dodd-Frank requires SEC registration of hedge funds. Increased disclosures by hedge funds and their advisers, which have in the past operated in an extremely opaque fashion largely ignored by regulators, is now required.
E. Fifth — Dodd-Frank seeks to protect consumers from a broad range of fraudulent and predatory practices. It creates the Consumer Financial Protection Bureau (CFPB), which consolidates most federal regulation of financial services. Most creditor providers (including mortgage lenders, payday loan outfits, and other nonbank financial companies) and banks and credit unions with assets over $10 billion will be subject to new regulation by the CFPB. Accounting firms will not.
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