As President Trump and the Republican Congress continue their efforts to remove or weaken regulations put in place under the Obama Administration, changes to banking rules may be some of the most consequential. To understand what’s in store for American banking regulations, it’s important to look at their foundation, namely the Dodd-Frank Act that was passed in the wake of the 2008 financial crisis. Much of the current debate over financial regulation stems from the many provisions in Dodd-Frank.  Read on for an overview of three of the law’s most important components and a look at its future.

The Dodd-Frank Act

In the wake of the 2008 financial crisis, Congress passed a law that sought to place additional regulations on banks, improve and unify oversight, and protect consumers in order to prevent another crisis from happening. While the actual success of that law–the Dodd-Frank Wall Street Reform and Consumer Protection Act, known as the Dodd-Frank–continues to be debated to this day, it is responsible for establishing many of the key components of the current regulatory system. The law created many new regulatory bodies that have churned out an even greater number of regulations, but for the purpose of this look, we will focus on three of the main consequences of the law.

Capital Requirements

The general idea behind bank regulations is that bank failures are extremely costly events that can pose serious risks to the entire economy, so we should regulate them to ensure their stability. One of the most universally agreed upon ways to improve the stability of the financial system is requiring banks to hold higher amounts of capital. Bank capital essentially includes all assets that do not have to be repaid, which allow banks to sustain losses if their other assets, like loans, decrease in value. Generally speaking, bank capital includes things like common stock and profits, which are used to fund a bank’s investments. While banks tend to fund most of their business with debt–namely deposits, which are a form of short-term, low-interest debt that is used to fund loans and other investments with higher returns–capital is simply another source of funding that also serves as a stabilizing force if a bank’s other assets decrease in value.

Writing in Slate, Matt Yglesias uses the example of a home loan to illustrate how bank capital works. When buying a home, you typically make a down payment and then fund the rest of the purchase with a loan. That down payment is your ownership or equity in the house–which you own and do not have to repay–and works along the same lines as bank capital. If the value of your house increases then the value of your equity increases. But if the home’s value decreases beyond what you have paid for it, then your loan is considered underwater–meaning you owe more than the house is worth. When the same thing happens to a bank, it becomes insolvent and fails. Higher capital requirements help ensure that banks can still operate when their assets drop in value.

If people chose a bank based on whether or not they viewed it as a safe place to put their money, then it would make sense for banks to have high levels of capital to appeal to customers. But because the federal government insures depositors via the FDIC, a bank’s capitalization matters less to individuals when choosing a bank. As a result, banks are incentivized to increase leverage and risk to increase their returns rather than capital to improve their stability. In return for the federal guarantee, however, regulators require banks to do their share to promote stability by mandating that they hold a certain amount of capital.

Dodd-Frank increased capital requirements in a number of ways. It set a higher leverage ratio–the ratio of a bank’s debt to capital–and created a separate risk-weighted requirement that uses looks at how risky different assets are. Mike Konczal, a fellow at the left-leaning Roosevelt Institute and proponent of Dodd-Frank, argues that both are necessary to ensure stability. A leverage requirement on its own would push banks to maximize their assets’ risk in order to increase returns. And because risk weighting is susceptible to bias, an overall leverage requirement helps act as a backstop in the event that risk estimates are off.

Some argue that requiring banks to fund their business with a higher amount of capital is more expensive for banks, which has effects on the economy as a whole. The thinking goes that forcing banks to fund themselves with capital reduces their ability to make loans and extend credit to businesses, which in turn slows the economy. While proponents of higher capital requirements note that although capital levels are higher than they were before the crisis, they remain low from a historical perspective and argue that the cost of capital is often overstated by banks. Some even dispute the notion that capital is costly for banks and argue that bankers’ opposition to higher capital requirements may have more to do with the way they are paid.

In addition to stricter capital requirements, Dodd-Frank also requires the banks to undergo regular “stress tests” to simulate their ability to handle various crisis scenarios. It also requires the largest banks to submit plans to wind themselves down in the event of a failure and set up a process for the FDIC and the Fed to liquidate a failing bank in order to prevent risk from spreading throughout the system.

The Volcker Rule

While you may not have heard people talk about the Volcker rule specifically, it’s more likely that you have heard someone like Senators Bernie Sanders or Elizabeth Warren discuss the need for Congress to pass a “21st Century version of Glass-Steagall.” Although there are important distinctions between the two, the original Glass-Steagall Act and the Volcker rule target the same issue. Both regulate or prevent banks from using deposits, which are insured by the FDIC, to make what are considered risky or speculative bets for their own gain.

For a better understanding, it’s worth taking a minute to look at the history of banking in the United States. The original Glass-Steagall law was put in place after the Great Depression to put a wall between commercial banks–traditional banks that take deposits and make loans–and investment banks–banks that trade investment securities and help companies issue stocks and bonds. In 1999, that law was repealed, leading to the formation of a handful of very large universal banks that do both commercial and investment banking. While most tend to think that the repeal of Glass-Steagall did not cause the crisis, the mega-banks that it gave rise to certainly played a role–allowing banks to grow quickly and experiment with new financial products likely contributed to the culture or risk-taking and lax regulation that worsened the crisis.

The Volcker Rule, named after former Federal Reserve Chairman Paul Volcker, sought to prevent the new universal banks from engaging in some of the riskiest behaviors of investment banks. Volcker played an important part in drafting Dodd-Frank and focused a lot of his attention on regulating risky bank activities. His eponymous rule sought to stop banks from doing what’s known as proprietary trading–or using their own money to make speculative investments for profit. Essentially, the law sought to mirror some of the effects of Glass-Steagall without breaking up the banks outright, choosing instead to limit the risks that institutions with a commercial banking arm could take. As Volcker sees it, the government has an interest in subsidizing and helping commercial banking with policies like FDIC insurance and potentially even bailouts–because taking deposits and making loans are important functions for the entire economy. However, he also believes that with a government subsidy, banks should not be allowed to take on excessive risk.

The Volcker rule has been criticized from all angles. Banks argue that it amounts to a significant attack on their ability to make profits, while reformers claim that it is full of loopholes and that it doesn’t fully accomplish its own stated goals. And those on the leftmost flank of the Democratic Party argue that the rule, and Dodd-Frank more generally, is not aggressive enough–while regulations under the law are notably more stringent than before the crisis, the government should have broken up the banks and forced larger structural changes onto the financial industry.

It’s also worth noting that the original goal of the Volcker rule was weakened when Dodd-Frank and the resulting regulations were drafted. Several loopholes were included that allow banks to continue to invest a portion of their assets in hedge funds and private equity funds as well as exceptions for trades done on behalf of customers.

The CFPB

When lawmakers set out to revamp financial regulation, they noticed several areas that did not have a single authority in charge–instead, a complex network of overlapping agencies was tasked with creating regulations to accomplish several different goals. A notable example of this was consumer protection, which prior to Dodd-Frank was under the control of about 10 different agencies. The fragmented nature meant that no single agency had a primary mandate to protect consumers, which made it difficult for the government to hold financial institutions accountable in cases where individuals were harmed. As a result, an important part of Dodd-Frank was the creation of the Consumer Financial Protection Bureau, an agency with wide powers to regulate and punish the misconduct of a wide range of institutions. The broad authority and unique structure of the CFPB have made it a controversial component of the reform law, with businesses and conservatives criticizing its authority and accountability structure and progressives arguing that it is essential to keep the industry in check.

The CFPB acts as a regulator in that it creates new rules for financial institutions and punishes them for misconduct. It is also streamlined the complaint process to help consumers take recourse with companies when they have a problem. It created a public complaint database, providing important information for consumers and helping regulators identify common problems. Aaron Klein, a fellow and research director at the Brookings Center on Regulation and Markets, compares the CFPB to Google and Yelp, as it provides a central place for information and reviews to help people make informed choices. In the five years that the CFPB has been in existence, it has provided more than $11 billion in relief for 27 million consumers.

Conclusion

As efforts to undo regulations passed in the wake of the financial crisis gain momentum, it’s important to look back at the law central to the current discussion: Dodd-Frank. Passed in 2010, Dodd-Frank marked the most significant regulatory revamp of the financial system since the great depression. It has been particularly controversial, attacked on the right for going too far and the left for not going far enough. Given its controversial nature, many of the law’s provisions are fairly vague, leaving a lot of latitude for regulators. As a result, the various agencies in charge of creating, updating, and enforcing regulations have a lot of control over how regulation works in practice. Changes to the underlying structure of the law will likely require new legislation, a prospect that does not seem likely given the need for bipartisan support in the Senate. But changes at the margins remain possible and even likely under the new administration. As President Trump continues his efforts to undo regulations and lessen the burden faced by businesses, we may see changes to the Volcker rule or even significant attempts to block its enforcement.

While there are a number of ways that existing laws and rules could be modified in the coming years, it’s important to remember the goals of the law that underlies the current regulatory framework. In many ways, Dodd-Frank was a compromise between various visions of financial reform, including new capital requirements to improve stability as well as the creation of new regulators and a complex set of rules to prevent risky behavior in the largest and most important financial institutions.

Kevin Rizzo

Kevin Rizzo is the Crime in America Editor at Law Street Media. An Ohio Native, the George Washington University graduate is a founding member of the company. Contact Kevin at krizzo@LawStreetMedia.com.

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On Wednesday, Congress approved a bill to rescue Puerto Rico’s finances, only two days before the U.S. territory’s deadline on a $2 billion payment. But Governor Alejandro Garcia Padilla declared that the island would still not be able to pay bondholders.

“On July 1, 2016, Puerto Rico will default on more than $1 billion in general obligation bonds, the island’s senior credits protected by a constitutional lien on revenues,” he wrote on CNBC’s website.

Puerto Rico is in deep financial trouble; as Law Street previously reported, the island is $72 billion in debt, and is due to pay a big chunk of it this week. It has already defaulted on previous payments, but the payment due on Friday includes about $780 million of General Obligation bonds, which are the most important and supposed to be paid off first.

Since the island is not expected to make that deadline, this would be its first default of GO bonds, which it is bound to pay according to its constitution. The White House has expressed warnings that unless the U.S. steps in and helps, the island could face a possible humanitarian crisis and complete financial chaos. Since Puerto Rico is not a U.S. state but a territory, it can’t file for bankruptcy, which would allow it to restructure their debt.

Last Minute Bill

The bill that was voted through, called the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA), will provide protection from any creditor litigations that could be brought to the Puerto Rican government. It will also put together a control board that will supervise restructuring of debts and finances. Both Republicans and Democrats unanimously supported it.

“If we don’t act before the island misses a critical debt payment deadline this Friday, matters will only get worse — for Puerto Rico and for taxpayers,” said Senate Majority Leader Mitch McConnell.

And President Obama said “This bill is not perfect, but it is a critical first step toward economic recovery and restored hope for millions of Americans who call Puerto Rico home.”

Puerto Rico’s Governor Padilla has mixed feelings about PROMESA, and wrote in a commentary on CNBC:

PROMESA is a mixed bag. On the one hand, it provides the tools needed to protect the people of Puerto Rico from disorderly actions taken by the creditors. The immediate stay granted by the bill on all litigation is of the utmost importance in this moment. Most importantly, the authority to adjust our debt stock provides the legal tools to complete a broad restructuring and route Puerto Rico’s revitalization.

On the other hand, PROMESA has its downsides. It creates an oversight board that unnecessarily undercuts the democratic institution of the Commonwealth of Puerto Rico. But facing the upsides and downsides of the bill, it gives Puerto Rico no true choice at this point in time.

The bill will provide some hope for the people of Puerto Rico. Thousands have already fled their homes on the island, while hospitals can’t treat patients without advance cash payments. Obama has promised to sign the new bill before July 1.

Emma Von Zeipel

Emma Von Zeipel is a staff writer at Law Street Media. She is originally from one of the islands of Stockholm, Sweden. After working for Democratic Voice of Burma in Thailand, she ended up in New York City. She has a BA in journalism from Stockholm University and is passionate about human rights, good books, horses, and European chocolate. Contact Emma at EVonZeipel@LawStreetMedia.com.

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In the wake of the 2008 financial crisis, the Justice Department levied record-breaking fines against many of the big banks involved in the meltdown, but very few individuals actually served time behind bars. That may finally be changing. According to a memo released on Wednesday, the Department of Justice (DOJ) is shifting its priorities to focus on prosecuting specific individuals who are responsible for financial wrongdoing.

“One of the most effective ways to combat corporate misconduct is by seeking accountability from the individuals who perpetrated the wrongdoing,” wrote Deputy Attorny General Sally Q. Yates in a memo to all federal prosecutors. Yates outlined six “key steps” that should guide prosecutors in their handling of corporate misconduct cases. While many of these steps are not necessarily new, the memo seeks to standardize the DOJ’s priorities going forward.

So far, billions of dollars have been collected by the DOJ from fines and civil penalties from major banks for the roles that they played in the financial crisis. However, very few individuals have actually been prosecuted, and even fewer were sentenced to time in prison. This has lead to some harsh criticism of the DOJ and the way that it handles financial crimes.

In an article about the recent DOJ shift, the New York Times notes:

The Justice Department often targets companies themselves and turns its eyes toward individuals only after negotiating a corporate settlement. In many cases, that means the offending employees go unpunished.

While using massive fines allow for record breaking headlines, it also shifts the burden of punishment from the individuals who defrauded the public to a company’s shareholders. Some argue that shareholders should also share in the punishment, as they have a lot of control over a company’s management, but few also argue that the responsible individuals should escape punishment.

The policy shift outlined in Yates’ memo will both prioritize individual prosecution as well as help compel companies to cooperate with investigations, specifically in terms of providing information about responsible individuals. The first point in Yates’ memo instructs prosecutors not to give cooperation credit to a company unless it provides information about all of the people responsible. This cooperation credit can significantly reduce the punishment that companies and individuals receive.

Although the DOJ is not directly admitting that its previous policies were insufficient, Yates does emphasize that her memo marks a significant change. In a speech given at New York University Law School, Yates said:

Now, to the average guy on the street, this might not sound like a big deal.  But those of you active in the white-collar area will recognize it as a substantial shift from our prior practice. While we have long emphasized the importance of identifying culpable individuals, until now, companies could cooperate with the government by voluntarily disclosing improper corporate practices, but then stop short of identifying who engaged in the wrongdoing and what exactly they did.

While this memo is certainly notable, it’s actually bringing some white collar prosecution standards in line with established standards for all criminals. In her speech to NYU Law School, Yates also notes that this is how it works for criminals who give information about their co-conspirators to the authorities. She uses the example of a drug trafficker, who can receive a cooperation agreement for informing on other criminals, but will not get any relief if he or she does not give information about the cartel boss. While ending special treatment for corporations is certainly a popular idea, it’s also a little disheartening to hear that hasn’t already been the norm.

This does mark a sort of reprioritization at the DJO, but the question remains: will it matter? Prosecutors face a wide range of challenges when they try to prosecute corporate crime. Yates acknowledges these challenges in her memo, but it is worth noting that this isn’t the first time people have called on regulators to focus on individuals.

The issue isn’t that the penalties for financial crimes are too weak, rather it is simply very difficult to prosecute people in corporate cases. In order to convict someone, prosecutors must trace misconduct to individuals and show intent behind their actions. This can be particularly challenging for issues at the magnitude of the financial crisis, which can involve wrongdoing at several levels of a company, but be difficult to tie executives to. The DOJ can also have a very hard time getting information about what happened; because many banks operate internationally other countries’ laws can restrict the information that is available to U.S. prosecutors.

The recent shift will hopefully make companies more likely to cooperate and provide useful information about individuals, but the prosecutorial challenges remain. Even after the DOJ’s recent announcement, reform advocates remain skeptical. Dennis Kelleher, the head of financial reform watchdog Better Markets told the Huffington Post, “Based on their past dereliction of duty, no one should believe anything DOJ says until they see actual, concrete and repeated prosecution of supervisors and executives.”

Yates is right to say that prosecuting responsible individuals is the best way to discourage future misconduct, but whether that can and will happen remains to be seen. These changes are a step in the right direction and acknowledge the importance of public confidence in regulators, but don’t expect to see many executives in prison any time soon.

Kevin Rizzo

Kevin Rizzo is the Crime in America Editor at Law Street Media. An Ohio Native, the George Washington University graduate is a founding member of the company. Contact Kevin at krizzo@LawStreetMedia.com.

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