Briefing Report: The Dodd-Frank Act and the Consumer Financial Protection Bureau

Federal and State Authority and Market Uncertainty
Wednesday, May 25, 2011

Overview: Dodd-Frank

The collapse of the global financial system in September 2008, caused by the bursting of the U.S. housing bubble and the breakdown of the subprime mortgage market, provoked an expensive, taxpayer funded bailout of financial institutions (the Troubled Asset Relief Program - TARP) to stabilize the national and international economy from further disruptions. The financial collapse and its effects, as well as the very unpopular TARP, coupled with Barack Obama's election to the presidency, triggered federal efforts to impose an aggressive regulatory regime on the nation's financial system. It would result in the most significant expansion of federal, and indirectly, state power over the nation's financial system.

In June 2009, within six months of taking office, the president introduced a proposal for "a sweeping overhaul of the financial regulatory system, a transformation on a scale not seen since the reforms that followed the Great Depression." 1 He was not wrong. The President's proposal quickly made its way to Congress, where the House acted first, passing a bill in December 2009 on a party line vote (where Democrats supported and Republicans opposed). The Senate followed in May 2010, also on a party line vote, and in late June, House and Senate conferees finished reconciling the two versions, sending the bill, the Dodd-Frank Wall Street Reform and Consumer Protection Act, to the president. He signed it on July 21, 2010. The nearly 900 page act, the stated intent of which is 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," 2 became the new regulatory scheme for the nation's financial system.

Dodd-Frank leaves almost no aspect of financial activity in the U.S. untouched. Among its many changes, the most notable ones expand and change federal supervision and oversight of financial institutions, form a new bankruptcy resolution process for large financial companies and increases capital reserve requirements. It also changes the regulation of over the counter derivatives, changes the regulation of credit rating agencies, and it changes corporate governance and executive compensation practices. Dodd-Frank also prohibits banks from participating in proprietary trading and from owning or investing in a hedge fund or private equity fund (known as the Volcker Rule), requires registration of investment advisers to private funds and alters the securitization market. Not least of all, Dodd-Frank creates several new agencies, the most contentious of which, the Bureau of Consumer Financial Protection, will be responsible for implementing and enforcing compliance with financial laws regulating most consumer financial products and services. In creating this new agency, Dodd-Frank also sought to resolve long-running policy disputes over federal preemption of state consumer finance law, which in turn provides, if only indirectly, significant new powers for state authorities over financial institutions.

Due to the complexity and breadth of the new law, many of Dodd-Frank's provisions are not set to take effect until the federal rulemaking processes finish, which were estimated to take at least a year and a half from the time of enactment. While most of Dodd­­-Frank's changes are directed at large national and multi-national financial institutions, through the Bureau of Consumer Financial Protection, nearly all financial institutions, services and products in America will be affected.

The Bureau of Consumer Financial Protection

Dodd-Frank created the Bureau of Consumer Financial Protection (Bureau) as an independent agency within the Federal Reserve, which is prohibited from interfering with Bureau functions. As noted above, the Bureau is charged with regulating consumer financial products and services under federal law. The Bureau is headed by a director who is appointed by the President, with the advice and consent of the Senate, for a term of five years. The Bureau is subject to financial audit by the GAO, and is required to report to the Senate Banking Committee and the House Financial Services Committee bi-annually. The Bureau may promulgate regulations, which can only be "stayed" by the Financial Stability Oversight Council (also created by Dodd-Frank, to oversee the various federal financial regulatory agencies) with an appealable 2/3 vote. The Bureau is comprised of five units: 1) Research; 2) Community Affairs; 3) Complaint Tracking and Collection; 4) Office of Fair Lending and Equal Opportunity; and 5) Office of Financial Literacy. The Bureau will obtain enforcement authority under the Enumerated Consumer Laws (generally the most significant federal consumer financial protection statutes enacted before Dodd-Frank) and begin most activities on the Designated Transfer Date (the date specified authorities will transfer from other agencies to the Bureau), which is currently set for July 21, 2011. The Bureau's authorities are far reaching, as its jurisdiction will include banks, credit unions, securities firms, payday lenders, mortgage-servicing operations, foreclosure relief services, debt collectors and other financial companies, and student loans.

Federalism and Preemption of State Banking Laws

Because of its unprecedented authority over the wide range of financial products and services available to consumers today, the Bureau's authorities present prospective conflicts to financial institutions within the various states, and to state authorities and policy makers as well. Historically, there has been a bright line between federal and state authority over commercial activities, with federal authority over state law granted by the Supremacy and Commerce Clauses of the Constitution, yet constrained by Tenth Amendment ("The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people").

Federal banking laws permitting federally-chartered banks, the National Bank Act (NBA) for national banks and the Home Owners' Loan Act (HOLA) for federal savings banks or thrifts, allow significant preemption of state laws regarding lending and other financial services. Before Dodd-Frank, federal law had been generally interpreted by federal banking regulators to effectively preempt state laws over banking and other financial institutions.

The federal Office of the Comptroller of the Currency (OCC) preempted state laws generally concerning mortgage lending, and the federal Office of Thrift Supervision (OTS) enacted similar rulings regarding federal savings associations. Broad federal preemption authority was affirmed by the U.S. Supreme Court in 2007 in its Watters v. Wachovia Bank, N.A. ruling, which resulted after a Michigan state mortgage regulator prohibited a Wachovia operating subsidiary from lending in the state after it surrendered its state license.

Many of the most obvious conflicts between Dodd-Frank state laws and regulations already pre-existed Watters v. Wachovia: between the Enumerated Consumer Laws and any state laws and between state consumer financial laws and laws applicable to national banks and federal savings associations (charter conflicts). Dodd-Frank is mindful of these conflicts, and establishes a new framework for resolution generally in favor of expanding state authority. Dodd-Frank preempts state law or regulation only if it "is inconsistent with the provisions of this (Act), and then only to the extent of the inconsistency." (Section 1041 (a)1) 3 Dodd-Frank establishes that state law is not inconsistent if it provides greater protection than federal laws. Dodd-Frank then provides authority to the Bureau to determine if the state law is inconsistent with federal laws. So not only does the Bureau regulate financial institutions with federal authority, it in turn has the authority to grants states the power to regulate financial institutions to provide greater protection than federal laws. In short, there is no regulatory "safe harbor" for financial institutions; compliance with federal standards provides no guarantee that legal requirements for financial institutions have been met.

New Powers for State Attorneys General and State Regulators

Ironically, without the action of any state legislature, Dodd-Frank has significantly expanded the authority of state attorneys general and state financial regulators. Arguably one of the most problematic aspects of Dodd-Frank's weakening of federal preemption is it strengthens the ability of state attorneys general to prosecute potential violations of Dodd-Frank. This is not to say that the law should not be enforced, or that consumers should not be protected against abuses by the financial institutions with which they do business. Rather, it recognizes the political reality of partisan, elected state attorneys general and their presumed ambitions for higher office, e.g., Eliot Spitzer, whose methods were characterized by the president of the U.S. Chamber of Commerce in 2005 as "the most egregious and unacceptable form of intimidation we've seen in this country in modern times." 4 Dodd-Frank actively contemplates direct action by state attorneys general, as acknowledged by the Bureau's appointed (but not yet confirmed by the Senate) director Elizabeth Warren saying, "The state attorneys general are natural partners for the consumer agency." 5

Dodd-Frank specifically authorizes state attorneys general to bring actions against persons (other than national banks and federal savings banks) to enforce Dodd-Frank and its regulations; it provides them authority to pursue remedies provided by Dodd-Frank; and it provides them authority to pursue remedies provided by other laws. Many of these same authorities under Dodd-Frank extend to state regulators too, who are authorized to bring actions against state licensed or chartered entities to enforce Dodd-Frank and its regulations. It also grants state regulators the authority to pursue remedies provided by Dodd-Frank, and the authority to pursue remedies provided by other laws.

In addition, Dodd-Frank, under certain conditions, authorizes state attorneys general to bring actions against national banks and federal savings banks to enforce its provisions and regulations. Dodd-Frank also allows state attorneys general and state regulators to bring actions to enforce the Enumerated Consumer Laws as provided in those laws.

Summary

In seeking to re-regulate the nation's financial system, to prevent the collapse experience in September 2008, and to protect consumers from abuses, Congress and the Obama Administration enacted in Dodd-Frank the most sweeping expansion of public power over private finance. While this new law imposes many objectionable restraints over market activities, the ones many citizens will experience directly will result from the new Bureau of Consumer Financial Protection. The Bureau's authority, in addition to the intentional weakening of federal preemption, and the Bureau's ability to delegated authority to the state attorneys general and state regulators, will most likely work against the stated intent of Dodd-Frank.

It does not take much imagination to predict the problem this creates. All national financial institutions, and many regional ones, do business across state lines; one of the reasons financial institutions sought strong federal preemption standards before Dodd-Frank was to secure themselves from the difficulty and cost of complying with 50 inconsistent state standards and one set of federal standards. In generally reversing previous federal rules regarding preemption, Dodd-Frank, ironically, rather than "promote the financial stability of the United States by improving accountability and transparency in the financial system," it instead introduces regulatory and market uncertainty. The earliest tests of this will likely come after July, when the Dodd-Frank provisions go into effect. Advocates and opponents of Dodd-Frank expect a court challenge of some kind shortly afterward and are already preparing.

1 http://www.nytimes.com/2009/06/18/business/18nocera.html
2 http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=111_cong_bills&docid=f:h4173enr.txt.pdf
3 http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=111_cong_bills&docid=f:h4173enr.txt.pdf
4 http://www.ft.com/cms/s/0/49f461e4-13cb-11dc-9866-000b5df10621.html#axzz1MjEfekrV
5 http://www.businessweek.com/news/2010-12-02/warren-recruits-dodd-frank-enforcers-from-50-states.html

For more information on this report or other Banking & financial Institutions issues, contact Tim Conaghan, Senate Republican Office of Policy at 916/651-1501.