So far, you have read about past crises that have fueled change in this country—for example, The Great Depression. Did you know that, as recently as 2009, there have been financial crises that people in this country have had to deal with?
The United States suffered a financial crisis between 2007 and 2009 that was years in the making. It started around 2003 with cheap credit and little interest on mortgages (since the prime rate had fallen to around 1%). Over the years, this created a housing bubble of low-interest mortgages that could no longer keep up with the prime rate as it increased, or with the investments made in mortgages by many financial institutions of the time. So, when the housing bubble burst years later in 2007/2008 and the market collapsed, financial institutions were left holding millions and trillions of dollars of near-worthless investments in people's mortgages. As a result, millions of homeowners suddenly found themselves owing more on their mortgage payments than what their homes were actually worth! What followed was the Great Recession, a period of economic decline, costing many people their jobs, their savings, and their homes. A final result of this financial crisis was the passing of the Dodd-Frank Wall Street Reform and Consumer Protection Act to ensure a financial crisis like this never happens again. So, how does this Act protect us from another Great Recession?
The Dodd-Frank Wall Street Reform and Consumer Protection Act, known more informally as the Dodd-Frank Act (named after two politicians who sponsored the act—Senator Christopher Dodd and Representative Barney Frank) was a massive piece of legislation passed in 2010 by the President at the time, Barack Obama. The Act ensures a financial crisis like the US had between 2007 and 2009 will never happen again.
Click the tabs below to reveal some of the more important components of the Dodd-Frank Act, which ensures consumer protection by targeting the creators of the financial crises of 2007–2009: banks, mortgage lenders, and credit rating agencies.
The Act established the Financial Stability Oversight Council, the Orderly Liquidation Authority, and the Federal Insurance Office. They monitor the financial stability of major financial firms and insurance companies, and they assist with their dismantling should any be placed in receivership. The monitoring of major financial firms and insurance companies is important because their failure could have a serious impact on consumers and the US economy.
The Act established the Consumer Financial Protection Bureau (CFPB) whose main purpose is to prevent predatory mortgage lending (which was a catalyst of the 2007–2009 financial crisis) and to make it easier for consumers to understand the terms of a mortgage before agreeing to them. The result of their establishment deters mortgage brokers from earning higher commissions for closing loans with higher fees/interest rates as well as requiring that mortgage brokers not steer potential borrowers to loans that will result in the highest payments.
This rule restricts the ways banks can invest, limiting speculative trading and eliminating proprietary trading. This also means that banks are no longer allowed to be involved with hedge funds or private equity firms, since they are considered too risky and may lead to a bank's failure. It also prevents banks and other financial institutions, which are "too big to fail," from taking large risks that may end up being harmful to the economy.
The Act created the Securities and Exchange Commission (SEC) Office of Credit Ratings. This office is charged with ensuring that credit agencies provide meaningful and reliable credit ratings of the individuals, businesses, and any other entities they evaluate. This is because during the 2007–2009 financial crisis, many credit rating agencies were accused of contributing to the crisis by giving out favorable, but misleading, investment and credit ratings.
The Act strengthened the existing whistleblower program that was promoted by the Sarbanes-Oxley Act (SOX). A whistleblower is anyone working for a company that brings forward claims against their employer (i.e., any witnessed unfair business practices). The Dodd-Frank Act established a mandatory bounty program in which whistleblowers can receive up to 30% of the proceeds from any lawsuit settlements as well as the ability for a whistleblower to come forward up to 180 days after a violation is discovered.
Let's Practice
Now, use the information provided above to answer the following questions about the Dodd-Frank Act and the financial crisis of 2007 – 2009.
What entity was established by the Dodd-Frank Act to monitor the finances of major financial institutions?
- Sarbanes-Oxley Act
- Consumer Financial Protection Bureau
- Financial Stability Oversight Council
The Financial Stability Oversight Council was created to monitor and supervise the financial stability of financial institutions.
The Financial Stability Oversight Council was created to monitor and supervise the financial stability of financial institutions.
The Financial Stability Oversight Council was created to monitor and supervise the financial stability of financial institutions.
What does the SEC Office of Credit Ratings protect?
- an entity's credit score
- misleading credit reports
- an individual or business's credit history
The SEC Office of Credit Ratings protects individuals and businesses from having their credit evaluated and reported in a misleading way.
The SEC Office of Credit Ratings protects individuals and businesses from having their credit evaluated and reported in a misleading way.
The SEC Office of Credit Ratings protects individuals and businesses from having their credit evaluated and reported in a misleading way.
What were the three entities that helped create the 2007–2009 financial crisis?
- mortgage brokers, credit rating agencies, and banks
- credit unions, credit scores, and mortgage brokers
- banks, credit rating agencies, and credit unions
Banks, mortgage brokers, and credit rating agencies all helped the rise of the 2007–2009 financial crisis.
Banks, mortgage brokers, and credit rating agencies all helped the rise of the 2007–2009 financial crisis.
Banks, mortgage brokers, and credit rating agencies all helped the rise of the 2007–2009 financial crisis.
What does the Volcker Rule prevent?
- prevents individuals from taking out large, risky loans
- prevents banks from taking large investment risks
- prevents financial institutions from investing in mortgages
The rule prevents banks—or other large financial institutions, which are essentially too big to fail—from taking large risks (i.e., unsafe investments) that could impact the economy in a harmful way.
The rule prevents banks—or other large financial institutions, which are essentially too big to fail—from taking large risks (i.e., unsafe investments) that could impact the economy in a harmful way.
The rule prevents banks—or other large financial institutions, which are essentially too big to fail—from taking large risks (i.e., unsafe investments) that could impact the economy in a harmful way.
Summary
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