Banking Regulation: An Overview of the Banking Act of 1933, The Consumer Financial Protection Bureau and the Dodd-Frank Act of 2010

2 12 2014

Mark Ellis, Ph.D. Alumnus – Loyola University Chicago School of Law

Introduction

This article will provide a brief overview of banking regulation, which has transpired since the 20th century. As such, an overview of the Banking Act of 1933[1], the establishment of the consumer financial protection Bureau, and the Dodd Frank Wall Street Reform and consumer protection reform act will be presented. Such legislation and regulatory bodies have been enacted in reaction to the overwhelming financial crisis that has transpired in the United States[2]. These reforms will be examined in light of the current economic and political landscape in the United States. Further, some of the major criticisms of the regulations and enforcement agencies will be presented.

The Banking Act of 1933

Congress enacted the Banking Act of 1933 in order to impose banking reforms[3]. The rationale behind the act was to regulated banking activities and to prevent practices such as undo diversion of funds, provide safer use of the assets of banks and regulate interbank control.[4] In this act, there was the creation of the Federal Deposit Insurance Corporation also known as the FDIC, which is a Corporation in the United States and operates independently so as to guarantee the safety of depositor accounts.[5] Over the process of time the amount of deposit guarantees have risen to $250,000 and remains the maximum amount as of 2014[6].

Of note, The Banking Act of 1933 is often referred to as the Glass-Steagall Act. This legislation prohibited banks from trading securities with client deposits creating unnecessary risk. Moreover, limitations were set on banking and investment activities which would allow for up to 10% of the capital in banks service but only 5% of their capital and small business investment companies. Under this act, substantial limitations were put in place regarding purchasing and selling securities. Interestingly, despite the safety mechanisms were put in place under this act, much of the act has been repealed over the years. The rationale behind the repeal is that some of the legislation was among other issues, too inhibiting.[7]

However, there are quite a number of provisions that are still in effect which require banks to provide its district Federal Reserve Bank and Federal Reserve Board and national banks to provide the Comptroller of currency a series of reports on their affiliates.[8] Further, there are also old revisions that remain in place which will establish criminal penalties for misconduct by any directors or officers of the Federal Reserve system member banks and gives power to the Federal Reserve to remove them if such officers or directors are found only liable for such conduct.[9] Moreover, the legislation mandated restriction affiliation between commercial and investment banks. Further, no entity or person could engage in business of issuing, underwriting, selling, or distributing securities and deposits.[10]

Although varying components of this legislation has been repealed, much of the legislation still exists today. Interestingly, criticisms of the repeal purport that portions of legislation that were repealed can be directly linked to the financial collapse of 2007 and 2008. As such, in reaction to the financial collapse that rocked the global economy further legislation was enacted in order to help prevent such a crisis again.

The Dodd Frank Act of 2010

The financial meltdown of 2007 and 2008 is often coined as the Global Financial Crisis. Due to the threat of collapse of large financial institutions, it is considered by quite a number of economists that such was the worst financial crisis since the Great Depression. Although the crisis was not considered a Depression, it is often referred to as “The Great Recession.”[11] As such, the Dodd Frank Act of 2010 is considered major legislation, and establishes regulations as not seen since the Great Depression.[12] The Dodd Frank Wall Street Reform and Consumer Protection Act contain what is known as the Volcker Rule 619 (12 USC 1851) which limits speculative activity by banks which some hold that such activity played a key role in the financial crisis of 2007 through 2010.[13] Much of what has been repealed in the banking act of 1933 has been directly replaced with current legislation under Dodd Frank. This relatively recent piece of legislation prohibits banks from engaging in speculative investments that created not only high risk but also did not benefit their customers. Essentially, it is a ban on proprietary trading by commercial banks where deposits are used. As previously mentioned, quite a number of legal experts and analysts purport that much of Dodd Frank fills in the gaps that were created by the repeal of earlier legislation.[14] As such, federal law and regulatory bodies have been put in place in order to protect the financial sector of the United States and seek to help provide stability and avoid the financial calamity that have disrupted the financial markets.

The Consumer Financial Protection Bureau

On July 21, 2011, an independent agency named the Consumer Financial Protection Bureau was formed and established under the Consumer Protection Act and Dodd Frank Wall Street Reform.[15] Yet again, in reaction to the financial crisis of 2007 and 2008, this agency was created to protect the consumer and the financial market. It gives direct oversight to lending agencies, debt collectors, banks, and other financial institutions that exist in the United States under the jurisdiction of the federal government.[16] As with a number of other federal laws designed to protect consumers and the financial sector, lawsuits have been filed challenging the constitutionality of the formation and operation of such an institution.[17] As with many of the previous regulatory actions enacted by Congress, questions as to whether or not such legislation and regulatory bodies are actually constitutional seem to be an ongoing argument against such protections.[18] Nevertheless, the majority of the laws and regulatory operations exist with the sole purpose of providing stability, transparency, integrity, and protection to the financial sector are the aims of these Federal laws and governmental agencies.

The Consumer Financial Protection Bureau seeks to promote fairness and transparency for financial services, products, mortgages, credit practices, that directly impact the American people. Because of these federal laws and regulatory agencies, the United States government can better ensure that the American people will not be harmed to the level and capacity as they were in years past. Many of these laws, no doubt, will be repealed, modified, or revised. As such, the consumer financial protection Bureau that gives oversight of the financial sector will no doubt assist in bringing about a higher level of integrity in the financial markets by protecting the American people.

Conclusion

As the financial markets are volatile by their very nature, there are certain levels of risk that exist no matter how many laws are passed, or regulatory bodies are established. As such, any potential financial threats in the future can only be speculative at this point. The ongoing cycle of financial prosperity and economic collapse is certainly nothing new to the United States. Nevertheless, as lawmakers and regulators seek to better protect the American people by establishing appropriate laws and regulations, the harmful practices in years past can be mitigated or altogether eliminated as much as possible. Whether the laws are revised, modified, or repealed; such legislation and regulation has been established as very necessary in order to prevent the same mistakes of the past.

References:

[1] Berle, Jr., Adolf A. (1934), “Banking Reform”, in Wilcox, Clair; Fraser, Herbert F.; Malin, Patrick Murphy, America’s Recovery Program, London; New York: Oxford University Press

[2] Burns, Helen M. (1974), The American Banking Community and New Deal Banking Reforms, 1933-1935, Westport, CT: Greenwood Press,

[3] Garten, Helen (1991), Why Bank Regulation Failed : Designing a Bank Regulatory Strategy for the 1990s, New York: Quorum Books

[4] Oftentimes the Banking Act of 1933 is referred to as the Glass-Steagall Act which played a key role in the separation of commercial and investment banking.

[5] FDIC. “FDIC: Who is the FDIC?” Retrieved 3/24/2014

[6] Ibid.

[7] Barth, James R.; Brumbaugh Jr., R. Dan; Wilcox, James A. (2000), “The Repeal of Glass–Steagall and the Advent of Broad Banking”, Journal of Economic Perspectives 14 (2): 191–204

[8] Alper, Carl E. (1934), “The Banking Act of 1933 in Operation and the Contemplated Modification”

[9] “Regulation of Holding Companies”) and 30. “The Glass–Steagall Act of 1933”, Harvard Law Review, Legislation 47 (2), December 1933: 328.

[10] Ibid.

[11] Although still debatable, several top economists purport that the 2009 fiasco was the worst financial crisis since the Great Depression and also warned of potential risks if proper steps are not taken so as to prevent further calamity. Retrieved from: http://www.reuters.com/article/2009/02/27/idUS193520+27-Feb-2009+BW20090227

[12] Paletta, Damian; Lucchetti, Aaron (July 16, 2010). “Senate Passes Sweeping Finance Overhaul”. Wall Street Journal. Retrieved March 22, 2014.

[13] “Former U.S. Treasury Secretaries Endorse Volcker Rule”, WSJ, retrieved March 23, 2014.

[14] Paletta, Damian; Lucchetti, Aaron (July 16, 2010). “Senate Passes Sweeping Finance Overhaul”. Wall Street Journal. Retrieved March 26, 2014.

[15] “Learn About the Bureau”. United States Consumer Financial Protection Bureau. Retrieved March 24, 2014.

[16] Ibid.

[17] Hall, Christine. “Dodd-Frank Unconstitutional Power-Grab, Says New Lawsuit.” Competitive Enterprise Institute. Competitive Enterprise Institute.

[18] Ibid.

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