University of Washington

The Dodd-Frank Act; Does it Impede U.S. Banking?

Mitchell Jackson
MGMT 320 B
Ruth Huwe
February 22nd, 2017
 This paper will discuss some of the debate surrounding the Dodd-Frank Wall

Street Reform and Consumer Protection Act, hereinafter referred to as simply the Dodd-

Frank Act. While the act passed with bipartisan support in 2010, the legislation has

recently become highly disputed, with Donald Trump pledging to get rid of the act

completely in place of his own regulatory plan1. There is a strong divide between those

who believe that the costs of compliance to Dodd-Frank hinder U.S. banks competitive

position and are unfairly distributed, and those that believe the regulation is warranted

and succeeds in addressing underlying causes of the financial crisis. Finally, I will also

provide my opinion on the subject, carefully considering the pros and cons of both

arguments, and give my recommendation on what should stay the same, and what should

be amended.

The 2007-08 recession was a complete and utter mess, with multiple institutions failing

their duties and some even committing outright fraudulent acts. Since the crisis was so

multidimensional and impactful, people are extremely opinionated on which contributing

factor is to blame primarily, was it the big banks? Or greedy mortgage brokers? Or even

the deregulation of underwriting and negligent ratings agencies? In general, if you blame

the big banks you are much more likely to favor Dodd-Frank, if you dont, you are more

likely to be against. For the sake of time, we are going to take at least some increased

regulation of the financial sector as warranted, and focus on arguments of both sides as to

whether certain aspects of the Dodd-Frank Act are a hindrance to U.S banking. With that

clarification out of the way, lets dive in.

1 Antoine Garza, With A Stroke of The Pen, Donald Trump Aims to Wave Goodbye to
the Dodd Frank Act, www.forbes.com (Feb. 3rd, 2017)

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 Opponents of the Dodd-Frank Act consider the legislation to be an unorganized

and overly complex statute that was passed with haste in response to large political

pressures2. The biggest problem opponents argue, is that the act impedes the growth and

competitiveness of the U.S. banking industry, with proponents responding that this

regulation is necessary in face of Wall Streets extremely aggressive position during the

housing bubble. Supports further contend that Dodd-Frank does it job in addressing the

financial sectors conflicts of interest that led to the 07-08 recession.

The opposition claims that a major flaw of Dodd-Frank is that large burdens of

regulation are unfairly placed on smaller, local financial institutions in spite of the fact

they were not main contributors to the financial crisis. One section that gets scrutinized

for this is the Durbin Amendment, which imposes a regulatory control on the fee paid

by retailers when buyers use a debit card3. This effectively raises the cost of doing

business for all banks and causing them to pass this cost onto consumers. In addition, the

large increase in required disclosures and compliance that all banks are now subject to,

affect smaller intuitions more heavily relative to larger banks since they are unable to

spread this cost across scale (similar to the decreased debit card fees).4 The evidence that

represents these claims can be seen through the decreasing availability of free checkings

account (approximately 75% in 2012 to 39% in 2015)5 and a decrease in the number

2 David John, Passed Hastily, Dodd-Frank is a Counterproductive Mess,

https://usnew.com, (October 17, 2011)

3 Jeb Hensarling, After Five Years, Dodd-Frank is a Failure, https://wsj.com (July 19,
2015)

4 Marshall Lux, Dodd-Frank is Hurting Community Banks, https://nytimes.com (April

14, 2016)

5 Jeb Hensarling After Five Years

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small banks in comparison to the total banking industry due to closures and mergers.

This is a huge problem in the eyes of the opposition because one of the main claims of

Dodd-Frank is that it would help mitigate the systemic risk of too big to fail (TBTF)

companies and they see small bank closures as a signal that big banks are even more

likely to receive future potential bailouts due to gaining power.

Not surprisingly, a lot of these issues with Dodd-Frank were unforeseen as it is not in the

governments interest to deter loans to small businesses/consumers or increase banking

fees at a local level. Supporters of the act, however, cite that this has largely become an

issue where small banks over exaggerate, and is unwarranted given that small banks have

done just fine compared to their larger competitors in terms of return on assets.6 Quite

the contrary, some economists believe that an extremely low interest rate is what is

hurting local banks the most and once this rate increases, availability of capital for

smaller communities and profitability of small banks will increase back to more desirable

levels.7 Nonetheless, this issue relating to Dodd-Frank has garnered increased media

attention in the last several years, and relief for small and medium banks is one of the

only areas in which reporters expect relatively bipartisan support.

Trumps administration is concerned with the possibility that the U.S. banking industrys

stake as a global powerhouse is at risk and believes it is being impeded by increased

regulation and restriction. For example, investment banks in the past have participated in

trading riskier investments that allow them to earn additional profit for shareholders and

6 Kate Davidson, Dodd-Franks Effect on Small Banks is Muted, https://wsj.com

(October 4, 2015)

7 Victoria Finkle, Warren: Dodd-Frank Rules Arent Hurting Small Banks Very Much,
https://americanbanker.com (Feb 12, 2015)

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the owners of their hedge funds/private equity funds. Due to the Volcker Rule that just

got implemented in 2015, banks are restricted from several forms of proprietary trading

and some major banks have shut down these desks completely in response8. The Volcker

Rule aims to eliminate the default risk that these banks incur when participating in riskier

proprietary trading, specifically the risk that this poses to depositors money (can be

considered government money/taxpayer money as the Fed insures deposits up to

$250,0009). Furthermore, the opposition does not solely blame investment banks for the

losses they suffered on derivative and futures trading during the housing crisis and

believe this broad restriction is too strict. They argue restricting all proprietary trading

impedes investment banks in their ability to compete with global banks and will result in

illiquid domestic markets for consumers investments due to lack of available market-

making10. Adversaries also reference the transition of investment talent from big banks,

which they consider a more important industry, to private equity firms/hedge funds and

the large current losses banks must sustain due to being required to exit investments they

have in long derivatives.11

Proponents of Dodd-Frank reply that the Volcker Rule is necessary considering the

underlying problem in allowing banks to participate in risky, illiquid investment despite

their inherent need to be a stable industry for consumers. Advocates argue that the

Volcker Rule is a step in the right direction in eliminating this gigantic conflict of interest.

8 Kevin Roose, Citigroup to Close Prop Trading Desk, https://dealbook.nytimes.com (Jan 27, 2012)

9 Federal Deposit Insurance Corporation, https://fdic.gov/info

10 Hal Scott, Implications of the Volcker Rules for Financial Stability, https://corpgov.law.harvard.edu
(Feb 5, 2010)

11 Investopedia, What is the Purpose of the Volcker Rule?, https://investopedia.com (June 23, 2015)

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They argue that each of the major historical cases of absolute bank failure has been when

banks participate in overly risky loan underwriting and trading while being the same

banks trusted with holding federally insured deposits12. They claim this contradiction is

the root of the TBTF classification and intolerable systemic risk, and that these banks

gamble with creditors money in proprietary trading (several forms of derivative trading

are similar to aspects of casino gambling) because they know that the government will

likely bail them out as otherwise an outright Depression 2.0 could occur (Lehman

Brothers is exempt here since it was purely an investment bank). In response to the

oppositions point that this hurts U.S. bankings global competitiveness, and to get rid of

conflict of interest completely, some advocates argue Dodd-Frank does not go far

enough. These individuals would like to see a reinstatement of the Glass-Steagull Act of

1933, which requires complete separation of commercial and investment banking

services for holding companies13. This would separate federally insured deposits from

the riskier functions of investment banks and would allow these types of banks to go back

to participating in proprietary trading for profit.

Given my research I would assert my position as taking neither the far left nor the far

right, and instead would like to see a compromise between the two sides as I see validity

in part of each sides claims. In regards to big banks, I whole-heartedly disagree with the

notion that big banks were clueless in their exposed risk to credit default swaps and their

holdings of mortgage backed securities. I therefore contend that they must of known, or

at least had some idea, that since their deposits were federally insured and they had vast

12 James Rickards, Repeal of Glass-Steagull Caused the Financial Crisis https://usnews.com (Aug 22,
2012)

13 James Rickard Repeal of Glass-Steagull

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power, they were indeed view by the government as TBTF. I believe that this conflict of

interest is the single most important thing that must be prevented, as big banks will

continue to do sell shady investments to the American people (when regulation fails) as

long as there is a believe that there will only be minor repercussions for their actions. I

believe that the Volcker Rule has good intentions, but I agree that banning most

derivatives trading for investment banks does seem a bit too harsh and contradictory by

definition. I could see how re-implementing a separation between commercial and

investment banks in order to allow proprietary makes sense in function (in the decade

after its repeal, the market soared then crashed, but worked for 60 years prior), but there

would likely be huge opposition from bank lobbyist as this would require bank splits and

possibly a bank holiday similar to the one of the 1930s. I could see increased disclosure

of proprietary trading and increased access to the market (creating liquidity) as possible

solutions to mitigating risk, therefore allowing banks some access to proprietary trading

and efficient regulation.

On a global competitive level, I see no material sign that Dodd-Frank is hindering

American banks to compete. Almost all of the banks that were negatively affected by the

financial crisis have rebounded to at least become profitable again and nearly all have

been allowed to rid themselves of direct government controls in the form of board seats

and material equity shares (see Citigroup, Bank of America, etc.). I believe that these

regulations are warranted especially considering that Wall Street execs and managers

avoided criminal penalties for the financial crisis and that the banking industrys

complaints are unwarranted considering the magnitude of the damage they could of

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caused without the government bailout (imagine if these banks failed, going to every

ATM and not being able to withdraw a cent).

In terms of smaller intuitions, I believe there must be immediate action in

lowering the amount of costs associated with compliance, especially since interest rates

have remained low in the past five years. The government should be encouraging branch

openings, active lines of credit for small business, and allowing the American people

access to basic banking functions not deterring local banks from providing these services.