The Great Recession and the Balance of Regulation

The Subprime Mortgage Crisis of 2008 was perhaps one of the most embarrassing and destructive moments for the financial institutions of America. A combination of poor regulation, inaccurate bond ratings, and explosive synthetic CDO’s led to an economic catastrophe. Fractured by corruption and greed, the U.S. suffered its worse recession since World War II. Nearly “10 million people faced crippling foreclosures,”[1] lost their homes, and suffered massive financial losses. Furthermore, “unemployment rose to 10%,”[2] wreaking havoc on the workforce. As if the financial burden wasn’t heavy enough, “as the crisis spread wider, so did suicide rates.”[3] The aftermath of the crisis was devastating, and everyday people were paying the price for investment firms’ negligent actions. Consequently, an unrelenting demand for regulation emerged. However, would the regulation that followed become a blessing or a burden?

­­­­­ In an effort to combat such devastating loss, the Dodd-Frank Act was passed in 2010. The Dodd-Frank Act aimed to protect consumer investors by increasing corporate responsibility and oversight. First and foremost, the act targeted the very behavior that led to the crisis with the Volcker Rule. This rule blocked banks from engaging in speculative proprietary trading, “specifically limiting trades involving risky derivatives.”[4]

Another important part of the act was the creation of the FSOC (Financial Stability Oversight Council). The FSOC was an imperative creation, as this council is responsible for ensuring firms everyday investors rely on don’t become “too big to fail.”[5] Firms were “routinely regulated by stress checks,”[6] and were required to keep enough cash on hand so that they can survive when recessions hit.

Furthermore, in an effort to combat reckless financial services that pose high risk to consumer investors, the CFPB (Consumer Financial Protection Bureau) was created. The CFPB was an important addition, as this bureau is responsible for the educating and protecting consumer investors from “risky financial services,”[7] many of which were purposely clouded by confusing financial lingo.

While the intentions of the Dodd-Frank Act were benevolent and necessary, time has revealed this regulation heavy legislation was imperfect. One flaw that has emerged is that the Dodd-Frank Act “did not take bank size into account,”[8] and all institutions were subject to the same regulation no matter their size and operation goals. As a result, many small banks and credit unions suffered. While the act has done much more good than bad, modifications needed to be made to lessen the net regulatory burden while still ensuring investor safety. Under the Trump administration, the regulations imposed under the Dodd-Frank Act were eased for small to medium sized banks, an adjustment made with a “surprising amount of bipartisan support.”[9] Essentially, now small banks are “exempt from costly stress tests, no longer have to comply to the Volcker Rule, and have more flexibility with capital requirements.”[10] With this new wiggle room, community banks and credit rooms are much better equipped to serve local communities. As an effort to protect investors, the reformation also added “safeguards for Americans taking out student loans, and requires credit companies to require free credit monitoring.”[11]

While we would like to think there will never be another recession, the probability is that they are inevitable from time to time. While it is impossible to fully prevent and protect a nation from one, it will be interesting to see if the current regulation and safeguards can suppress the damage more successfully than we have seen in the past. Even more important, it is imperative that a healthy balance of regulation and freedom is maintained as the markets continue to change and grow. Only time can tell if we are erroring to heavy on one side or the other.

[1] Viktoria Ney, “Many Americans Ended up Homeless,” Business Insider, August 7, 2018, https://www.businessinsider.com/heres-where-those-who-lost-homes-during-the-us-housing-crisis-are-now-2018-8 [2][2] Anne Field, “What Caused the Great Depression,” Business Insider, July 8, 2021, https://www.businessinsider.com/what-caused-the-great-recession [3] Ney, “Many Americans Ended up Homeless.” [4] Kelly Anne Smith, “How The Dodd-Frank Act Protects Your Money,” Forbes, July 20, 2020, https://www.forbes.com/advisor/investing/dodd-frank-act/ [5] Smith, “How The Dodd-Frank Act Protects Your Money.” [6] Smith, “How The Dodd-Frank Act Protects Your Money.” [7] Smith, “How The Dodd-Frank Act Protects Your Money.” [8] Smith, “How The Dodd-Frank Act Protects Your Money.” [9] Jacob Pramuk, “Trump Signs the Biggest Rollback of Bank Rules Since Dodd-Frank,” CNBC, May 24, 2018, https://www.cnbc.com/2018/05/24/trump-signs-bank-bill-rolling-back-some-dodd-frank-regulations.htmls [10] GOBanking Rates, “Trump Is Deregulating Banks,” Nasdaq, February 12, 2019, https://www.nasdaq.com/articles/trump-deregulating-banks-heres-what-means-you-2019-02-12

[11] Pramuk, “Trump Signs the Biggest Rollback.”