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What is Dodd-Frank? And is Trump about to cause another financial crisis?

The US President is expected to order a review of the Dodd-Frank Act

Josie Cox
Business Editor
Friday 03 February 2017 10:08 GMT
What is the Dodd-Frank Act?

Donald Trump is expected to order a review of the Dodd-Frank Act, which was implemented in the aftermath of the 2008 financial crisis to prevent a repeat of the worst financial crash since the Great Depression.

But what actually is Dodd-Frank and does it really matter if it’s scrapped?

What is Dodd-Frank?

The Dodd-Frank Wall Street Reform and Consumer Protection Act, as it is official known, was introduced in 2010 in direct response to the financial crisis. It was broadly considered the most comprehensive set of financial regulatory reform measures implemented since the Great Depression to stop financial institutions from being reckless.

Firstly, the act created the Financial Stability Oversight Council, a body which is effectively in charge of looking for risks within the financial system, especially as so many of the big banks are so interconnected and considered ‘too big to fail’: if one did fail, we could see a domino effect.

The council has the right to break up banks that it thinks could pose a systemic risk to the global financial order. It also has the ability to demand that banks hold higher reserves, or cash buffers, to minimise a squeeze. Separately, the Dodd-Frank Act also created the Consumer Financial Protection Bureau, to oversee consumer financial products, such as mortgages.

A key part of the Act is the Volcker Rule, which restricts the way that banks are allowed to invest and places restrictions on speculative trading. It also restricts banks from engaging in so-called proprietary trading, or trading for the firm’s direct gain, instead of on behalf of a client.

So in effect, the rule is designed to separate the investment and commercial businesses of banks.

Finally, the Dodd-Frank Act also creates incentives for whistle-blowers.

Why does Donald Trump not like it?

Donald Trump implied during his campaign that he thinks that getting rid of - or at least dramatically reforming - the Dodd-Frank Act will encourage economic growth and create jobs.

"Dodd-Frank has made it impossible for bankers to function," he told Reuters in an interview back in May last year. "It makes it very hard for bankers to loan money for people to create jobs, for people with businesses to create jobs. And that has to stop."

Does this mean we’re at risk of facing another financial crisis?

Donald Trump is not alone in thinking that Dodd-Frank needs to be reformed. Many experts say that it’s inadequate and hasn’t achieved what it was designed to. It hasn’t successfully led to the split up of many banks that are arguably too big to fail. Just think of Goldman Sachs, Bank of America and JP Morgan.

But there’s a strong feeling among experts that it’s better than nothing. It’s stopped many of the biggest players in the industry from making massive, risky bets that could go dramatically wrong and cost billions. It’s also tightened up consumer protection.

And there’s a real possibility that if regulation in the US were scaled back in a big way, it could pressure regulators elsewhere to become more relaxed, simply in order to stay more competitive.

Some economists have even been bold enough to say that getting rid of Dodd-Frank could indeed pave the way for another crisis.

What makes matters a lot worse, is that many experts believe that global financial systems and economies are more vulnerable now than they were ahead of the last financial crisis. So if we do suffer another major crash, the damage has the potential to be a lot more grave.

Central banks around the world have already slashed interest rates to record lows leaving them with limited ammunition to do more to stimulate economic growth. Government debt has also sky rocketed over the decade since the last crisis.

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