RUNNING HEAD: DODD-FRANK: AN ECONOMIC AND IDEOLOGICAL HISTORY 1

RUNNING HEAD: DODD-FRANK: AN ECONOMIC AND IDEOLOGICAL HISTORY 1 Dodd-Frank: An Economic and Ideological History Lucas Delort George Warren Brown School of Social Work Washington University in St. Louis October 13, 2014

DODD-FRANK: AN ECONOMIC AND IDEOLOGICAL HISTORY 2 Dodd-Frank: An Economic and Ideological History In the wake of the Financial Crisis of 2007-2008, Congress and the White House acted together to protect the American taxpayer and consumer and promote national economic stability. The result was the Dodd-Frank Wall Street Reform and Consumer Protection Act (henceforth referred to as Dodd-Frank), which was passed by the 111 th Congress with and became effective on July 21, 2010. Dodd-Frank represents the most extensive financial reform since the 1930s (Davis Polk & Wardwell, 2010). The bill serves four major purposes: 1. to improv(e) accountability and transparency in the financial system, 2. to end too big to fail as a theory and philosophy of the financial sector, 3. to protect the American taxpayer by ending bailouts, and 4. to protect consumers from a number of practices seen as abusive (Dodd- Frank, 1) Despite its bipartisan beginnings during the mid-2000s, it passed along party lines with strong support from Democrats and strong opposition from Republicans. Policy Context Deregulation of Financial Sector Contemporary deregulation of the financial sector began during the Carter Administration. The Depository Institutions Deregulation and Monetary Control Act (DIDMCA) of 1980 removed maximums on deposit account interest rates, allowed institutions to set any interest rate they chose on loans, and allowed the merging of banking institutions. Two years later, Ronald Reagan signed the Garn St. Germain Depository Institutions Act, which allowed adjustable-rate mortgages and deregulated savings and loan associations. DIDMCA and Garn-St. Germain often cited as a cause of the savings and loan crisis of the late 1980s (e.g., FDIC, 1997). Alan Greenspan, chairman of the Federal Reserve from 1987-2006, argued during the late 1990s that derivatives markets remain unregulated, a position cemented into law in 2000 with the

DODD-FRANK: AN ECONOMIC AND IDEOLOGICAL HISTORY 3 Commodity Futures Modernization Act. This self-regulation is often cited, including by Greenspan himself, as leading to the explosion speculative trading, including credit-default swaps, that led to the financial collapse; for example, Warren Buffett called derivatives financial weapons of mass destruction devised by madmen (Andrews, 2008; BBC, 2003). In 2004, the Securities and Exchange Commission (SEC) allowed investment banks to increase the debt they could hold, a change that allowed the mortgage-backed securities practices of the mid- 2000s to take hold (New York Times, 2008). Financial Crisis of 2007-2010 The confluence of deregulation policies of prior decades, including adjustable-rate mortgages, self-regulation policies, and increased debt-holding, led to a change in lending practices from the conservative to the risky. For example, the creation and proliferation of subprime mortgages, bundled high-risk mortgage tranches, and credit default swaps (the purchase of an insurance policy to bet on the failure of a company bond) created a financial market which was growing on risky lending and the ability to bet against that risk. With banker and trader income and bonuses tied to per-transaction fees, the Wall Street environment became focused on short-term, personal financial gain, with little consideration of the long-term or reallife effects of trading practices. For the trader interested in building her or his personal wealth, bundling toxic (the lowest-rated) tranches of mortgages for eager buyers is worth it, when fees can add up to $1 million per year (Glass, Davidson, and Blumberg, 2009; Lewis, 2010). Legislative History and Political Process Before the Financial Crisis The deregulation of the financial market happened across party lines. Policies under Democratic leadership, including Carter and Clinton, and Republican leadership, including

DODD-FRANK: AN ECONOMIC AND IDEOLOGICAL HISTORY 4 Reagan, Greenspan, and George W. Bush, lowered federal regulation of banks and lending institutions. Similarly, both Democrats and Republicans called for overhauls of regulatory processes, fearing a crisis if deregulation occurred. During the Bush administration, there were seventeen calls for the investigation of the safety of these lending practices (Office of the Press Secretary, 2008). In particular, the administration and its officials targeted Freddie Mac and Fannie Mae. In fiscal years 2002 and 2005, administration budgets warned that the growth and size of Fannie Mae and Freddie Mac were problematic. After Freddie Mac announced in 2003 that they manipulated earnings, Treasury Secretary John Snow, a Republican serving within the Bush administration, called for a new Federal agency to regulate and supervise the financial activities of our housing-related government sponsored enterprises, repeating a similar call in 2005. Republican Greg Mankiw, Chairman of the Council of Economic Advisers, called for similar measures in 2003 and 2004, stating that a new regulator should have sufficient strength and credibility as well as broad authority against the perceived systemic risk. In 2004 then-department Secretary of the Treasury Samuel Bodman called for reform of government sponsored enterprises (GSEs), which includes Fannie Mae and Freddie Mac. After the Start of the Crisis After it became public that two Bear Sterns hedge funds invested in the collapse of the mortgage securities market in July 2007, President Bush calls on Congress to pass a reform package for Fannie Mae and Freddie Mac, repeating these calls in December 2007, and every month beginning in March 2008 until Congress finally acts in July 2008 (Office of the Press Secretary, 2008). On February 13, 2008, President Bush signs the $152 billion Economic

DODD-FRANK: AN ECONOMIC AND IDEOLOGICAL HISTORY 5 Stimulus Act of 2008, which provides rebates to families making less than $75,000 per year, with the effect of boosting spending by 3.5% among rebate-recipients (Williams, 2008). In late 2008, almost two years after the start of the Great Recession, President-to-be Barack Obama made it a policy priority to overhaul the United States financial system. On January 23, 2009, three days after taking office, President Obama submitted the American Reinvestment and Recovery Act, an $831 billion economic stimulus which was signed into law on February 17, 2009 (Lim, 2009). He also proposed a regulatory reform called A New Foundation in June 2009. This proposal called for greatly increased Federal Reserve oversight of the financial system, including regular collecting of reports and regular stress tests; the disbanding of the present Securities and Exchange Commission and installation of a new one; required hedge funds, private equity firms, and credit card banks to register under the new SEC for monitoring; regulation of derivatives and securities; and increased transparency and consumer education; among many other proposals (WSJ Staff, 2009; Office of the Press Secretary, 2009). Dodd-Frank A New Foundation was submitted, with some revisions, to the House. It passed as H.R.4173 Wall Street Reform and Consumer Protection Act of 2009 in December 2009 with zero supporting votes from Republicans (Office of the Clerk, 2009). The Senate passed bill S.3217 Restoring American Financial Stability Act of 2010 in May 2010 with one supporting vote from Republicans (Secretary of the Senate, 2010). Then, on July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was enacted. Dodd-Frank included many of the same major provisions as Obama s original A New Foundation proposal. In its final form, it was organized into sixteen provisions, creating 243

DODD-FRANK: AN ECONOMIC AND IDEOLOGICAL HISTORY 6 rules and requiring 67 studies, most of which would occur between six and eighteen months after its enactment (i.e., during calendar year 2011; Davis Polk & Wardwell, 2010). Proponent Ideologies During the Bush Administration, proponents of financial reform crossed party lines. As discussed above, President George W. Bush and many Republicans within his administration called for reforms of Fannie Mae, Freddie Mac, and other financial institutions and practices, with support from strong Democratic voices like Warren Buffett. Following the bailouts of financial institutions and the stimulus packages of 2008 and 2009, public opinion of financial reform polarized. Support for financial reforms under Obama were strictly along party lines, with Dodd-Frank being passed almost entirely by Democratic votes. Shortly after Dodd-Frank was passed, it gained support from the Independent Community Bankers Association for limiting the powers of big banks and providing equal access for small banks to the lending market (Khimm, 2011). Some Wall Street lobbyists have voiced acceptance of the law. The Securities Industry and Financial Markets Association has urged Republicans to let the law stand (Carney, 2011). Opponent Ideologies Dodd-Frank polarized the federal political environment. Republicans almost entirely opposed the bill in 2009 and 2010, with only one supporting vote within Congress. Senate and House Republicans have introduced bills to repeal parts or all of the Act. In 2011, the Republican Party s platform included a strong opposition to Dodd-Frank. Candidates have stated that Dodd- Frank is the thing that is most harming the economy, and describing it as a prime example of government overreach that is killing jobs by not allowing lenders to provide finances to entities that create jobs (Wyatt, 2011). They also stated that the bill would be bad for small banks

DODD-FRANK: AN ECONOMIC AND IDEOLOGICAL HISTORY 7 and the mortgage lending market. Conservative foundations supported this thinking, including the Heritage Foundation. In 2013, Heritage stated that the onerous and costly bill merely increased costs for consumers (Katz, 2013), citing billions of dollars and millions of dollars needed for oversight and assessment, as well as the 50% decrease in no-fee checking accounts and the doubling in minimum balances between 2009 and 2011. The American Bankers Association takes the most extreme stance against Dodd-Frank. In 2009, ABA president Ed Yingling stated that Dodd-Frank was an attempt at blowing up everything and would leave the regulatory system in chaos for years (Applebaum and Dennis, 2009). On the other side, some have criticized Dodd-Frank for not being strong enough and for allowing it to be defanged by the financial industry. Wall Street lobbying groups spent $1 billion dollars to prevent the passing of Dodd-Frank, only to increase spending following its passing. Critics point to the fact that three years after Dodd-Frank, fewer than half of its rules have been enacted, and state that this can be attributed to leaving the responsibility of enacting change to Federal agencies that had done little to protect consumers in the past and which are vulnerable to outside influence (Rivlin, 2013). Conclusion Dodd-Frank represents the culmination of a long process of financial deregulation and a wide range of conversations on financial system overhaul. It was only after multiple calls for change that were followed by crisis that the reform occurred. During the reform process, ideologies polarized, and ideological response to policy creation range from opposition for its overreach and criticism for its weakness. As the years move forward, it will be seen what its long-term impact is on the financial system, and whether it will truly increase the security and confidence in consumer and business lending.

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