President Trump signed a huge rollback of Dodd-Frank bank regulations this week, with bi-partisan support from the House and Senate
While many Liberal groups are crying foul, it can be hard to figure out what exactly is going on and how this new law will affect you.
Here’s our take:
The Main Point: Fewer Banks Considered “Too Big to Fail”
One big criticism of Dodd-Frank is that it created a huge mechanism called Orderly Liquidation Authority (or OLA) so that the federal government can rescue large financial institutions from failure.
Dodd-Frank emerged from the 2008 financial crisis, is when Lehman Brothers declared bankruptcy, and several other large institutions were only saved by massive taxpayer bailouts.
Lawmakers decided that the government needed a more orderly way of bailing out large institutions—and one that wouldn’t be funded directly by the taxpayers.
Dodd-Frank’s OLA was designed to make other large institutions bail out their failing counterparts.
So what’s the Problem?
Unfortunately, creating a system of predictable bailouts gives banks every incentive to make risky decisions—knowing that if they fail they will be bailed out.
This is called “Moral Hazard.”
Critics of Dodd-Frank claim that when banks know a bailout is coming, they’re more likely to invest your money with high-risk high-reward investments. If the investments go well, they make even more money. And if they crash and burn, they won’t get hurt.
New York Times author Gretchen Morgenson pointed this out way back in 2012:
Many Americans probably think the Dodd-Frank financial reform law will protect taxpayers from future bailouts. Wrong. In fact, Dodd-Frank actually widened the federal safety net for big institutions. Under that law, eight more giants were granted the right to tap the Federal Reserve for funding when the next crisis hits. At the same time, those eight may avoid Dodd-Frank measures that govern how we’re supposed to wind down institutions that get into trouble.
In other words, these lucky eight got the best of both worlds: access to the Fed’s money and no penalty for failure.
That, in a nutshell is why Conservatives by and large support President Trump’s new policy.
What Else The Law Does
Along with reducing the number of banks that are “too big to fail,” this new law massively reduces regulations on mid-size banks.
You see, along with the “too big to fail” safety net, the government forced dozens of banks to jump through regulatory hurdles designed to keep them from failing in the first place.
Those institutions also would not have to undergo stress tests or submit so-called living wills, both safety valves designed to plan for financial disaster.
But since the threshold is raised, most of those banks can go back to business without regulations, safety nets, or moral hazard.
Let us know in the comments if you have any questions!