Top 10 Fixes for Dodd-Frank

As Congress moves to reform the financial regulatory framework known as Dodd-Frank, Columbia Business School’s Charles Calomiris weighs in on needed changes.

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Former Sen. Chris Dodd, D-Conn., one of the architects of the legislation passed in the wake of the 2007-2009 financial crisis, speaks on the fifth anniversary of the Dodd-Frank Act in 2015.
Bill Clark/CQ Roll Call

With the U.S. Congress close to finalizing a major overhaul of the Dodd–Frank Wall Street Reform and Consumer Protection Act, it’s important to ask: Does Dodd-Frank need fixing?

Enacted in the wake of the 2007-2009 financial crisis, the sweeping financial regulation was considered a signature accomplishment of former President Barack Obama but deemed “a disaster” by President Donald Trump.

For Columbia Business School’s Charles W. Calomiris, the Henry Kaufman Professor of Financial Institutions and director of the Program for Financial Studies, the fallout from Dodd-Frank has been less than ideal: The number of unbanked Americans has grown, the share of banks offering free checking accounts has fallen, bank service fees are up 111 percent, and the number of credit card accounts has fallen by 15 percent. Big banks complain of reduced profitability while smaller banks feel disproportionately targeted by new rules and compliance burdens.

“Dodd-Frank is not the Bible, it had lots of sins of omission and commission,” says Calomiris, author of the 2017 book “Reforming Financial Regulation After Dodd-Frank” and the recent paper “Has Financial Regulation Been a Flop? (or How to Reform Dodd‐Frank)” published in the Journal of Applied Corporate Finance. “We created huge compliance costs. We didn’t solve the main problems that gave rise to the financial crisis. And we’re actually harming consumers.”

Speaker Paul Ryan announced earlier this month that the House would be “soon” voting on a Senate-approved bill to rewrite the 2010 Dodd-Frank Act. While that bill is focused on easing oversight of small and mid-sized banks, how should Congress look in a broader sense to reform Dodd-Frank? Here is a Top 10 list of suggested reforms from Calomiris.

1. Reform housing finance policy. Key to reducing systemic risk, this reform has several parts: (a) Move away from subsidizing risk through the Federal Housing Administration and government-sponsored enterprises such as Fannie Mae and Freddie Mac, as well as curtail Federal Home Loan Banks’ interest rate subsidies for high-risk mortgages; (b) Promote homeownership by giving downpayment matching to low-income households; (c) Offer to subsidize the costs of locking in long-term rates for low-income households; (d) Limit banks’ loan exposure to real estate.

2. Make prudential capital regulation more effective and dynamically responsive. This reform has three parts: (a) Replace the morass of capital requirements that banks face with a single minimum tangible book equity-to-assets ratio of 10 percent and a minimum tangible book equity-to-risk-weighted assets ratio of 15 percent; (b) For large banks, additionally require that they issue 10 percent of assets in contingent convertibles (or CoCos, which are a form of debt that converts into equity) with a high conversion trigger related to the market value of equity relative to assets; (c) Measure asset risk weights using interest rates on the loans or securities held by banks (which are truer measures of risk than the concocted measures from banks’ own models).

3. Simplify cash requirements for banks. Congress should replace the two Basel liquidity requirements with a simple requirement that banks hold 20 percent of their debts in the form of remunerative (interest-bearing) cash reserves at the Fed, which would help to eliminate the complexity and distortions produced by the current requirements.

4. Reform stress tests. This fix has three parts: (a) Make the models that underlie stress tests much more transparent by revealing assumptions with a lag; (b) Improve stress tests by forecasting cash flows by line of business, using managerial accounting data; (c) Eliminate Fed control of dividend decisions for banks so long as banks pass the quantitative stress test. This would help to ensure effectiveness and Fed accountability, while limiting inappropriate incursions of the Fed into bank management.

5. Repeal the Volcker Rule. Named for former Fed chairman Paul Volcker, this section of Dodd-Frank bars banks from using their own accounts for speculative trading. But studies find substantial benefits from allowing bank holding companies to make markets in corporate, municipal, and foreign debts. Congress not only should repeal Dodd-Frank, it should also provide a limited carve-out for securities inventories of dealers from leverage and liquidity regulations, relying only on risk-based minimum capital requirements for those holdings.

6. Repeal the CARD Act and Durbin Amendment. The Credit Card Accountability, Responsibility, and Disclosure (CARD) Act of 2009 restricted disclosure, pricing, and risk-management practices by issuers as a means of protecting consumers from practices that Congress deemed unfair. But research has found that nonprime consumers have simply migrated from credit cards to finance-company loans, boosting the shadow banking system’s share of consumer credit to high-risk consumers. Meanwhile, the Durbin Amendment to Dodd-Frank capped certain fees associated with debit card transactions for banks with over $10 billion in assets, but it appears that banks simply offset this loss by increasing their deposit fees – in effect forcing some bank customers to cross-subsidize the transactions of others. The distortive CARD Act and Durbin Amendment have each needlessly raised costs to consumers.

7. Repeal Title II bailouts. Title II of Dodd-Frank created an Orderly Liquidation Authority (OLA) with the mandate of efficiently liquidating any large, complex financial company that is close to failing during a government-declared financial emergency. A number of academics, however, criticize Title II for institutionalizing bailouts by enacting a new bankruptcy law specifically to deal with the winding down of large financial institutions, which more likely provides a road map for future bailouts rather than a blueprint for preventing them.

8. Restore some Fed power to act as a lender of last resort. Dodd-Frank curtailed the Fed’s power by requiring Treasury approval of lending programs as well as by limiting the Fed’s ability to be a lender of last resort to nonbanks. But this introduces uncertainty into the market. Rather, if nonbanks are aware of a government commitment to provide assistance with clearly specified rules, the expectation of assistance can help to stabilize the financial system.

9. Phase out the increasingly Kafkaesque reliance on “guidance.” Unlike formal rule making that must adhere to the clear standards laid out in the Administrative Procedures Act, guidance can be extremely vague and effectively allows regulators to determine what violates compliance standards after the fact. This invites abuse of regulatory power. There has been a dramatic increase in reliance on guidance in recent years – a prominent example being the standards that determine whether a financial institution is a Systemically Important Financial Institution (SIFI) – which empowers prejudiced thinking and decreases predictability and impartiality of regulation.

10. Restructure Dodd-Frank’s new regulatory agencies. Two new organizations that were established by Dodd-Frank– the Financial Stability Oversight Council (FSOC) and the Office of Financial Research (OFR) – should be removed from the purview of the Treasury and established as independent sentinels to identify systemic problems, monitor regulatory enforcement, and propose new rules. Separately, the Consumer Financial Protection Bureau (CFPB), should be depoliticized by restructuring it as a bipartisan commission (like the SEC) that is subject to Congressional funding appropriations and limited to enforcing consumer protection laws.

About the researcher

Charles Calomiris

Charles W. Calomiris is the Henry Kaufman Professor of Financial Institutions at Columbia Business School, the Director of Columbia Business School...

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