- The financial crisis that swept the world in 2008 required massive bank bailouts to avoid an even deeper economic collapse. In 2010, U.S. lawmakers passed the Dodd-Frank Act, which sought to reduce risk in the banking system.
- In 2018, Congress and the Donald Trump administration scaled back many of the legislation’s provisions, viewing them as too onerous on small and midsize banks.
- The collapse of Silicon Valley Bank and other regional lenders in 2023 spurred renewed debate over Dodd-Frank among regulators, the private sector, and Congress.
In the wake of the 2008 financial crisis, the U.S. Congress created a sweeping financial regulation that its proponents hailed as a safeguard against future crises. That legislation came to be known as Dodd-Frank, short for the Dodd-Frank Wall Street Reform and Consumer Protection Act. Its provisions restricted banks from trading with their own funds (the “Volcker Rule”), heightened monitoring of systemic risk, tightened regulation of financial products, and introduced consumer protection initiatives.
Opponents of the law, however, have argued that it burdens smaller banks without meaningfully reducing risk. Following the collapse of Silicon Valley Bank (SVB) in March 2023, the largest bank failure since 2008, debate over the legislation has been rekindled. Some analysts contend that efforts to weaken Dodd-Frank, led by President Donald Trump in 2018, played a role in this most recent cycle of turmoil, while others argue that the law itself is partly to blame.
How did U.S. financial regulation develop?
Modern financial regulation has its roots in the 1929–1939 Great Depression, which featured a stock market crash, steep losses among banks that invested in high-risk stocks (known as speculation), and an ensuing financial panic that led to widespread bank runs. Ultimately, some 9,000 banks failed, and $7 billion in depositors’ assets were lost—more than $125 billion in 2023 dollars. Banking regulation before the crisis was sparse; when a bank failed, depositors were often left with nothing. With the Depression leaving a quarter of all Americans jobless, President Franklin D. Roosevelt introduced legislation to prevent similar financial devastation in the future.
The Banking Act of 1933 established the Federal Deposit Insurance Corporation (FDIC), which guarantees bank deposits up to a certain limit. It also imposed regulations, known as “Glass-Steagall” after their architects, to prevent deposit-taking commercial banks from speculating on stocks. One year later, the Securities Exchange Act created the Securities and Exchange Commission (SEC) to regulate the trading of stocks, bonds, and other securities, which include almost all tradable financial assets. But in the 1970s, a period of high inflation and interest rates set the stage for regulatory rollbacks, and a 1971 Supreme Court case [PDF] allowed for a broader interpretation of Glass-Steagall. After the United Kingdom eliminated restrictions on financial instruments known as derivatives in 1986, U.S. regulators followed suit, and the next decade was marked by a wave of pro-deregulation sentiment in advanced economies. In 1999, the Gramm-Leach-Bliley Act fully erased the barrier between commercial banking and investment banking erected by Glass-Steagall.
As banking regulations eased, derivatives took center stage. Derivatives allow two parties to enter into a contract based on the future price of some underlying asset, without either of them actually owning it. While derivatives were originally commodity-based, as in the case of agricultural futures, financial innovations moved derivatives toward interests as diverse as currency exchange rates and the weather. The Commodity Futures Modernization Act of 2000 (CFMA) caused a regulatory sea-change by exempting derivatives from federal oversight and creating a $600 trillion financial derivatives market; the size of the market increased sixfold [PDF] between the passage of CFMA and the 2008 financial crisis. The SEC loosened restrictions further in 2004, when it eliminated capital requirements, allowing financial firms to invest massive amounts of borrowed money (“leverage”).
What happened in the 2008 financial crisis?
In the early 2000s, the U.S. Federal Reserve, known as the Fed, sought to combat an economic downturn by lowering interest rates. The Fed’s efforts, alongside the deregulation of the 1990s, resulted in an explosion of mortgages issued to people with low credit scores (“subprime” mortgages). Investment banks bought those and other loans and bundled them into derivatives, which they called mortgage-backed securities. When the bottom fell out of the housing market in 2007, trillions of dollars worth of these securities were suddenly worth pennies on the dollar.
Large banks, no longer subject to capital requirements, had made massive investments in these risky derivatives. As mortgage defaults proliferated, banks with housing-market exposure faced steep losses and even bankruptcy. In March 2008, the investment bank Bear Stearns became the first financial giant to collapse, ultimately selling to J.P. Morgan for $10 a share, down from $172 a share a month before. Chaos quickly spread throughout the U.S. financial system and across the globe, as many deposit-taking banks had also been trading in speculative assets. In September 2008, the investment bank Lehman Brothers declared the biggest bankruptcy in U.S. history, driven in part by speculation in the derivatives market [PDF].
Fearing a domino effect of financial collapse, the Fed stepped in to rescue firms it deemed “too big to fail.” Economists continue to debate the total size of these bailouts, with estimates ranging from $500 billion (about 3.5 percent of U.S. gross domestic product [GDP] in 2009) to $29 trillion (double U.S. GDP in 2009). The bailouts, partially funded by taxpayer dollars, turned attention toward perceived regulatory failures to restrain excessive risk-taking and questionable practices by the country’s big banks. In the hope of preventing another such financial meltdown, the Democrat-led Congress passed Dodd-Frank in July 2010, largely along party lines. Its major provisions included the so-called Volcker Rule, Fed-mandated stress tests, and the empowerment of the FDIC to seize “too big to fail” firms.
What is the Volcker Rule?
Perhaps the bill’s most controversial provision was the move to ban banks from using their own money, rather than depositor money, to trade securities. This ban on so-called proprietary trading came to be known as the Volcker Rule, after its main proponent, former Fed Chairman Paul Volcker. He reasoned that financial firms that choose to take on speculative risks should not be government subsidized. Many economists maintain that proprietary trading exacerbated the 2008 financial crisis.
The rule faced particularly fierce opposition, and its implementation was ultimately delayed until July 2015. Many CEOs of large banks argued that proprietary trading wasn’t a cause of the crisis, pointing out that some of the largest failures of financial firms took place at institutions that did not take deposits and thus wouldn’t have been subject to the Volcker Rule. Some lawmakers and industry groups have called for repealing the rule entirely, arguing that it imposes high costs to fix something that wasn’t broken.
What other reforms did Dodd-Frank undertake?
Dodd-Frank established a series of new rules and agencies with the aim of reducing systemic risk, which exists when the failure of one firm threatens to destabilize the entire financial system. These included measures for banks to limit the overall risk they can take on, ensure they can be orderly broken up in bankruptcy, and expand federal oversight of their transactions.
New federal regulators. The fifteen-member Financial Stability Oversight Council (FSOC), chaired by the secretary of the treasury, was created to improve coordination among financial regulators. The FSOC can flag financial firms—including non-banks—for stricter oversight by the Fed, whose powers Dodd-Frank expanded beyond inflation and employment targets to include oversight of the financial system and bank solvency. It achieves this mandate by setting limits on bank debt, requiring banks to keep more money in reserve, and restricting how much debt they can leverage in investments. Previously, the SEC had limited leverage to a 12-1 debt-to-equity ratio, a measure of how much borrowed money a company has compared to its assets; in 2004, it eliminated the requirement for banks with more than $5 billion in assets. Dodd-Frank required the Fed to impose a 15-1 leverage ratio and conduct annual “stress tests” for large banks.
Consumer protections. The Consumer Financial Protection Bureau (CFPB), a part of the Fed, was formed in response to the perceived need for a single agency to combat widespread mortgage fraud and other financial industry abuses. The CFPB says that its enforcement actions have provided more than $16 billion in consumer relief from violations of various consumer financial protections laws. However, critics—including many Republicans—have called for making the bureau more accountable to Congress, and some lawmakers have called for abolishing it entirely.
Expanded FDIC authority. Until 2010, the FDIC exclusively oversaw commercial banks, but Dodd-Frank made the FDIC responsible for all firms designated as “systemically important.” It also introduced a new mechanism by which the FDIC can resolve failing banks. That process, known as orderly liquidation authority, established a procedure for restructuring or liquidating failing financial firms that would pose a danger to the U.S. financial system under traditional bankruptcy. Dodd-Frank also required financial institutions to submit “living wills” that outline their credit exposure and plans for an orderly dismantling in the event of financial distress.
Strengthened derivatives regulation. Experts say the financial crisis revealed crucial weaknesses in the market for so-called over-the-counter derivatives, which are lightly regulated private contracts (not traded on an exchange). Dodd-Frank reversed much of the CFMA’s deregulation [PDF], requiring many firms that trade derivatives to use a clearinghouse, which is a more strictly regulated intermediary between buyers and sellers. Some nonfinancial firms that use derivatives for more traditional hedging purposes are exempt from these requirements.
Some notable provisions, such as a restriction on incentive-based compensation for bank executives, have still not been implemented.
What changes did Trump make?
At the time of its passage, Dodd-Frank was opposed by nearly all congressional Republicans and many Wall Street executives, who criticized the legislation for burdening banks with too many restrictions, which they said stifled business. Trump pledged to dismantle Dodd-Frank when he took office in 2017, the first year since 2005 that Republicans controlled both Congress and the presidency.
In 2018, Trump signed the Economic Growth, Regulatory Relief, and Consumer Protection Act, which kept the Dodd-Frank framework but limited its reach. The bill, which won some Democratic support, was a scaled-back version of a more extensive overhaul proposed by House Republicans that would have included drastic cuts to the CFPB and a full repeal of the Volcker Rule. The compromise bill increased the threshold for stress tests from $50 billion to $250 billion, exempting many small and midsize banks from the requirement. In 2023, twenty-three banks participated in some version of the Fed’s stress tests, one-third less than participated in 2017 [PDF].
The rollback also made certain banks with less than $10 billion in assets exempt from the Volcker Rule, and Trump’s CFPB appointee, Mick Mulvaney, faced criticism for hobbling the bureau’s enforcement. However, many other provisions were retained, including derivatives regulations and expanded FDIC powers.
What is the debate over Dodd-Frank?
Debate has persisted over how much safer the law has made the financial system, and whether the costs are worth it. Many experts agree that Dodd-Frank reduces risk from the big banks, while detractors mostly argue that the safety measures came at the cost of reduced access to capital and credit, impeding economic growth.
Recent bank failures have returned the dispute over “too big to fail” to the fore. After Silicon Valley Bank (SVB) and Signature Bank collapsed in March 2023—the third- and fourth-largest bank failures in U.S. history—the Fed exercised a “systemic risk exception” to rescue bank depositors as part of the largest Fed bailout since the financial crisis. Some experts blame the Trump era rollbacks, especially the weakening of the Volcker Rule and lower threshold for stress tests, for the failures. Proposals have emerged in both chambers of Congress to roll back the rollbacks.
Other economists have questioned whether Dodd-Frank ever did enough to prevent even midsize banks from becoming big enough for their demise to wreak havoc on the financial system. (At the time of its collapse, SVB was the sixteenth-largest U.S. bank.) Those in this camp say that SVB would have failed regardless of the changes to Dodd-Frank, arguing that the Volcker Rule and stress-test metrics would not have captured the bank’s precarious financial predicament. They note that more sweeping reforms, such as breaking up large banks and setting size limitations on their growth, ultimately did not make it into the bill. As a result, they say, regulatory focus should now be on keeping banks smaller, more liquid, and better capitalized, rather than doubling down on the Dodd-Frank approach.
Yet another group of analysts has argued that Dodd-Frank caused the collapse of SVB and other regional lenders by making portfolios less diverse and the entire financial sector more fragile. These critics call for a full repeal of the legislation.
How does Dodd-Frank regulation compare internationally?
The law’s regulatory authority extends to the overseas operations of domestic banks, and to some U.S. operations of international banks. That regulatory ambit, alongside guidelines set by Group of Twenty (G20) countries, has standardized some financial regulation across advanced economies. Today, there are twenty-nine banks categorized by the Financial Stability Board (FSB), an international financial monitor, as “systemically important” [PDF], roughly the same number as a decade ago. Eight are headquartered in the United States, double the number in the countries with the next-most banks of that kind (China and France each have four).
Experts point out that U.S. regulations are generally more extensive than those in other advanced economies. Perhaps the most notable difference is the Volcker Rule; no other advanced economy has an equivalent. However, the rule’s authority extends to some foreign banks operating in the United States, and given the United States’ outsize role in the global financial system, the Volcker Rule has a wide application. Industry groups say the United States also has stricter derivatives rules and more stringent capital requirements than its European competitors. China, meanwhile, has tightened supervision of its financial institutions under President Xi Jinping. “While the U.S. government under the Trump Administration focused on easing financial regulation, China was engaged in exactly the opposite,” writes CFR’s Zongyuan Zoe Liu.
Stress tests have been implemented in several major financial hubs, including the European Union (EU) and Japan. EU banks become eligible for regulatory stress tests once they have thirty billion euros in assets, which at the time of the tests’ 2009 introduction was equal to around $50 billion, the original U.S. threshold. In Japan, stress tests have mostly been conducted by the banks themselves, rather than by regulators; in 2020, the country’s central bank began leading stress tests.
Many big banks argue that the more restrictive regulatory landscape in the United States harms the country’s global competitiveness. Some CEOs, including JPMorgan Chase’s Jamie Dimon, have said that high capital requirements reduce much-needed lending [PDF]. But critics point out that banks have remained profitable despite Dodd-Frank regulations. Since the crisis, U.S. banks have consistently recorded higher profits than their European peers.
Meanwhile, other experts say that financial instability poses a greater threat than regulation. “The SVB collapse could potentially weaken the U.S. government’s ability to conduct financial statecraft,” by exposing weakness in the U.S. financial system, says CFR’s Liu.
This Backgrounder examines the role of the U.S. Federal Reserve.
CFR’s Zongyuan Zoe Liu lays out the great-power implications of the Silicon Valley Bank collapse.
Experts William R. Rhodes and Stuart P.M. Mackintosh argue that a more robust Volcker Rule could have prevented the 2023 regional bank crisis.
Michael Greenberger, a professor at University of Maryland’s Francis King Carey School of Law, explains derivatives’ role in the 2008 financial crisis in this 2010 testimony before Congress [PDF].
This timeline tracked the global financial crisis.
This 2011 study by experts at the National Bureau of Economic Research found that lobbying activities by financial firms contributed to the financial crisis.
Steven J. Markovich contributed to this report. Will Merrow and Michael Bricknell created the graphics.