By Jim Kessler and Emily Liner Dismantle, dismiss or defend? Five years later, Dodd-Frank continues to be an enigma. Signed into law on a sweltering July day, its passage should have been a cathartic celebration in Washington. After all, it was the biggest financial reform law since the Dust Bowl. Yet even today, most Republicans still want to dismantle the law, and many Democrats simply dismiss it as weak tea. In fact, the typical Democratic office-seeker sounds off about Wall Street reform as if Dodd-Frank never happened.
But with the usual caveat that no law is anywhere near perfect, we should mark Dodd-Frank’s anniversary by vigorously defending it because it achieved something remarkable: It reformed our complex financial system not by closing off markets or criminalizing legitimate economic activities, but by setting up guardrails that encourage healthier behavior.
Because of Dodd-Frank, bank health has improved due to stricter capital requirements. Capital works like an airbag, cushioning the effect of losses. Dodd-Frank makes banks hold onto more capital so that they are better equipped to ride out choppy waters in the economy. Because of risk-weighted capital rules, banks must either get rid of their riskiest assets or shore them up with extra equity. Every year, the biggest banks must pass a simulated economic downturn test to see if they have the ability to withstand a stomach-turning recession. Now, they do.
For housing, mortgages come with new common-sense requirements that benefit both borrowers and lenders. Dodd-Frank caps mortgage fees and points on borrowers, and borrowers are better equipped to understand the terms of their mortgage thanks to the new mandate for disclosures in plain language on the cover sheet of new mortgage contracts. Meanwhile, lenders are less exposed to default risk because of the ability-to-repay rule on qualified mortgages, which ensures that borrowers can afford their mortgage payments. Plus, the entire system is stronger because the firms that securitize and resell loans are required to have skin the in the game by holding onto a portion of the risk exposure of each loan that does not meet these high mortgage lending standards.
In the exotic world of derivatives, Dodd-Frank reformed the swap market — not by wiping it out, but by adding transparency requirements that bring swap trades out of the dark and onto centralized records. Meanwhile, the Volcker Rule forced banks to move proprietary trading desks out of federally insured subsidiaries, so that taxpayers will never have to pick up the tab if these trades go bad.
Finally, stock market investors are better protected and more empowered. Spoofing — the cause of the 2010 Flash Crash — is now illegal, so that bad actors cannot move market prices to their benefit. Shareholders can make their voices heard on executive performance thanks to the new requirement for a “Say on Pay” vote. And the Securities and Exchange is better equipped to pursue wrongdoing because whistleblower reforms have led to a significant increase in reports of fraud.
Because of Dodd-Frank, our financial system is healthier and fairer than in the past. It is far better prepared to withstand an economic shock — Greece, Puerto Rico, or China, anyone? — without unraveling and sending the economy into a tailspin. It is far less likely to be the cause of a tailspin because of the failure of one or more firms that drag down others (see: MF Global, 2011). And it is far better positioned to allow banks to fail without involving taxpayer bailouts.
In his memoir, ex-Rep. Barney Frank wrote about “relitigating an issue that has been legitimately decided.” That’s good advice because the foundation of this law is where it should be. Sure, policymakers must keep pace with our rapidly evolving markets and remain ever vigilant of new risks, while also allowing the market to create new rewards. And of course, we must figure out what to do with Fannie Mae and Freddie Mac while keeping the 30-year fixed-rate mortgage readily available and affordable.
But on this, Dodd-Frank’s five-year anniversary, maybe the best thing we could do is to finally appreciate the importance and significance of this historic law and defend it from those who think it did far too much or nothing at all.
Jim Kessler is Senior Vice President at Third Way. Emily Liner is a Policy Advisor at Third Way.