Dodd-Frank: Will the bill overturn decades of industry influence?


The financial crisis had several authors–federal policies that opened the door to predatory mortgage lending, unregulated financial products, integrated firms that borrowed heavily from one another to invest in the "sure bet" of mortgage-backed securities, and hedge funds and insurers that sought to profit by mitigating risk through complex financial instruments. In the aftermath of the crisis, Congress passed and President Obama signed on July 21, 2010, the Dodd Frank Wall Street Reform and Consumer Protection Act to set new safeguards for the public, to rein in financial firms, to ensure oversight of new types of financial instruments, and to give regulators more tools to prevent another crisis.

The Dodd-Frank act and the hundreds of rules that regulatory agencies will have to adopt in the wake of its passage have been the subject of a massive lobbying campaign by the financial firms it is supposed to regulate. Those firms are among the most generous givers of campaign contributions–since the 1992 election cycle, when Congress weakened oversight of the government-sponsored enterprises involved in the secondary mortgage market, Fannie Mae and Freddie Mac, the finance, insurance and real estate sector has contributed more than $2.6 billion to federal candidates, political action committees and parties, according to the Center for Responsive Politics. Since 1999, when Congress and the Clinton administration deregulated financial firms by dismantling the Glass-Steagall Act, a Depression-era law that prevented kept banking and investment firms separate, companies and trade groups in the finance, insurance and real estate sectors spent a staggering $4.3 billion lobbying the House, Senate and executive branch agencies on a wide range of legislative and regulatory issues. In 2009 and 2010, when Dodd-Frank was under consideration, lobbyists reported some 1,172 clients with an interest in affecting the bill.

Since passage of Dodd-Frank, federal agencies implementing the law have logged more than 2,100 meetings with interests aiming to influence the many new rules that Dodd-Frank requires, including 83 with executives and lobbyists for Goldman Sachs, 73 with JP Morgan Chase, 58 with Morgan Stanley and 55 with Bank of America. The Sunlight Foundation Reporting Group is launching a new tracker to follow disclosures of meetings about Dodd-Frank implementation with the Treasury Department, the Federal Reserve, the Federal Deposit Insurance Corporation, the Securities Exchange Commission and the Commodity Futures Trading Corporation. Additionally, a dozen bills have been introduced to repeal the law or significantly amend it.

Despite its more then 2,300 pages, Dodd-Frank left regulatory agencies to spell out most of the specifics; there are 108 rulemaking deadlines this summer. That's one of the reasons lobbying on the bill has continued to pick up since it was enacted–lobbying firms reported 79 new clients interested in influencing Dodd-Frank since last July (listed here, by our Lobbying Tracker). Additionally, federal agencies charged with collecting and publishing new data sets lag behind in making that information available to the public. 

Dodd-Frank's preamble says the act's intent is to "To promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail’, to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes." In the coming days, we'll look at each of the major segments contributing to the financial crisis, and look at how Dodd-Frank effects them, and how they've affected implementation of Dodd-Frank in return.

Industry influence over Congress and regulatory agencies played a key role in the financial crisis that culminated in an unprecedented bail out of big banks, brokerages, government-sponsored enterprises, and auto manufacturers in the fall of 2008 and another of state and local governments in the winter of 2009. It had its beginnings in a series of laws and regulations adopted by the federal government after heavy lobbying by special interests to deregulate Wall Street stretching as far back, in some accounts, for decades. 

As the Financial Crisis Inquiry Commission's majority noted in its report on the origins of the crisis:

In the early part of the 20th century, we erected a series of protections—the Federal Reserve as a lender of last resort, federal deposit insurance, ample regulations—to provide a bulwark against the panics that had regularly plagued America’s banking system in the 19th century. Yet, over the past 30-plus years, we permitted the growth of a shadow banking system—opaque and laden with short-term debt—that rivaled the size of the traditional banking system. Key components of the market—for example, the multi-trillion-dollar repo lending market, off-balance-sheet entities, and the use of over-the-counter derivatives—were hidden from view, without the protections we had constructed to prevent financial meltdowns.

One chapter of that lengthy story was the passage of the Commodity Futures Modernization Act in 2000, a 262-page long bill that was tucked into an 11,000-page behemoth conference report, with little debate or oversight. Thanks to the efforts of Sen. Phil Gramm, R-Texas, and others, provisions to regulate derivatives markets and credit default swaps–proposed after the collapse and rescue of hedge fund Long Term Capital Management–were stripped from the final version of the bill.

In addition to the changes to the financial sector, Republicans and Democrats in the White House and Congress favored homeownership with tax breaks and generously supported government-sponsored enterprises to facilitate the market. In 1992, Congress enacted the Federal Housing Enterprises Financial Safety and Soundness Act, which set up a new regulatory regime for Fannie Mae and Freddie Mac, the congressionally created firms that kept the mortgage market flush with cash by buying mortgages from banks, replenishing their capital to write new mortgages. The bill, among other things, required Fannie and Freddie to take the lead in "developing loan products and flexible underwriting guidelines to facilitate a secondary market for mortgages for very low-, low-, and moderate-income families." In an effort to increase home ownership in the United States, the two government-sponsored enterprises would begin supplying subprime mortgage lenders with a seemingly endless stream of financing. Mortgage brokers soon followed suit.

One of the segments of the housing market that the act encouraged GSEs to expand was manufactured housing, which went through a crisis starting in 1997. Warren Buffett, whose Berkshire Hathaway has a subsidiary in the industry, wrote to his shareholders in February 2009, that that experience, "should have served as a canary-in-the-coal-mine warning for the far-larger conventional housing market."

Buffett explained that mortgage originators made loans to more and more questionable customers which were then turned into securities–mortgage-backed securities–that were sold to investors. "In an eerie rerun of that disaster, the same mistakes were repeated with conventional homes in the 2004-07 period," Buffett wrote, "Lenders happily made loans that borrowers couldn’t repay out of their incomes, and borrowers just as happily signed up to meet those payments."

By that time, the financial industry had undergone significant changes thanks to a 1999 law–the Financial Modernization Act, or Gramm-Leach-Bliley–passed by a Republican Congress and signed into law by President Bill Clinton, a Democrat. The law eliminated Depression-era rules designed to protect the country from the collapse of any one institution by keeping banking separate from investment firms, and was later strengthened to prevent banks from engaging in other types of business or growing too large through mergers and acquisitions. Data from the Federal Deposit Insurance Corporation show what happened next: in 1999, the year the law passed, the 10 largest commercial banks held 27 percent of the commercial bank deposits; by 2005, their share had climbed to 44 percent. In June of 2010, the last year for which data was available, the top ten banks held 47 percent of commercial bank deposits.

Federal policy encouraged more home ownership through flexible underwriting guidelines, Fannie Mae and Freddie Mac primed the pump by buying up billions of dollars worth of mortgages and repackaging the loans to investors, mortgage originators made sketchier and sketchier loans to customers, then sold them to the GSEs or to brokerage houses, all of which packaged them as mortgage backed securities that ratings agencies labeled "investment grade." The amount of debt issued was staggering: Gretchen Morgenson and Joshua Rosner reported in their book Reckless Endangerment that by 2005, investors held $4 trillion in debt guaranteed by Fannie Mae and Freddie Mac. U.S. Treasury debt at the time amounted to $4.7 trillion. Brokerages and banks sold the securities to investors, which ranged from big banks to union pension funds to insurers to individuals, in more and more complex configurations, including collateralized debt obligations (CDOs), CDOs squared and CDOs cubed.

Traders in CDOs hedged their bets through derivatives, credit default swaps, and other mechanisms, like the credit support annexes that insurance giant American International Group gave that guaranteed the value of CDOs. When the value collapsed, the federal government effectively took over AIG on Sept. 16, 2008, about two weeks after Fannie Mae and Freddie Mac were seized and two days after Lehman Brothers declared bankruptcy, and Bank of America announced it was acquiring Merrill Lynch.

Those moves occurred in an atmosphere of financial crisis, as firms, fearing the equivalent of a bank run, sought to hold on to their own capital and refused to lend to others. Banks that borrowed money short term to help employers meet payrolls had difficulty raising capital. The Federal Reserve and the Federal Deposit Insurance Corp. took measures in October 2008 to guarantee such loans, while Congress rushed through the Emergency Economic Stabilization Act, which authorized the federal government to spend up to $700 billion to buy toxic assets from financial institutions, restoring them to fiscal health (for a summary of government actions to aid the financial industry in 2008 and 2009, visit Subsidy Scope.

The crisis affected more than big banks and financial firms. In 2010, there were almost 7 million fewer jobs than in 2007, according to the Bureau of Labor Statistics. In 2008, the percentage of individual returns with taxable income filed with Internal Revenue Service fell to 63.6 percent, down from 74.8 percent in 2000, according to the Statistics of Income division of the IRS. That occurred as Congress authorized the Treasury Department to bail out banks and other financial industry players with up to $700 billion from taxpayers. Congress and the Obama administration tried to address the ensuing recession by spending another $787 billion for the American Recovery and Reinvestment Act in order to stimulate employment and plug holes in state and local budgets caused by their own collapsing tax revenues.