The Success And The Effects Of Dodd-Frank Act On The Banking Industry And The Proposed Brown-Vitter Bill

Includes: BAC
by: Tom Dorsey

The Dodd-Frank Act was designed to set high standards and create an environment that would prevent a repeat of the 2007-08 financial disaster. The Basel III requirements were designed to force big banks to hold enough capital to sustain a recession or market downturn that would put banks in jeopardy of the 'too-big-to-fail' scenario.

What the Dodd-Frank Act failed to do was write enough details into the Act. The Act intended to create strict rules for capital, leverage, liquidity, risk management and other requirements as companies grow in size and complexity, with significant requirements on companies that pose risks to the financial system. Dodd-Frank has and will continue to significantly expand the regulatory burden on financial businesses, including community banks.

What the TARP did do was forced all banks to give a lot of stock to the federal government, which the federal government sold at a later date after the companies recovered, and the value of the stock increase allowed the government to make an enormous amount of profit off these companies.

The U.S. Treasury actually loaned $431 billion dollars to companies in need. The Treasury trimmed its estimate for how much TARP will end up costing taxpayers to about $28 billion. Let's look at the individual banks.


The Federal government invested in 707 institutions and four years after TARP's launch, the government still owns stakes in 218 banks. Of the $245 billion to banks, the government has collected $268 billion (principle with interest). Dividend payments (read as interest) will jump to 9% from 5% after five years in TARP.

The government initiated a multi-stage rescue of AIG through both the Federal Reserve and Treasury. The Federal Reserve committed $112 billion and the U.S. Treasury $70 billion ($182 billion total) and after AIG paid it all back, the federal government made $17.7 billion profit.

The federal government invested $45 billion into Citi Group and with the sale of all Citi common stock was sold the government made $12.3 billion in profit. The government will still own a modest interest in Citi, through Trust Preferred Securities held by the Federal Deposit Insurance Corp. The FDIC must turn over the securities to the Treasury and the principal value of these securities are $800 million.

Bank of America (NYSE:BAC) repaid the federal government its entire $45 billion. BoA has paid $2.54 billion to the government in dividends/interest during this time.

As you can see, the large banks have purchased their stock back from the government at a substantial gain for the federal government. Many of the smaller banks have many challenges to their TARP loans.

The federal government has sold shares in 91 smaller banks for $1.5 billion, most of the time at a discount. Forty-nine have repaid $6.9 billion in TARP funds and an additional three have seen investments restructured, according to Treasury figures.

By most assessments, this would have to be considered a success. Big banks reorganized and refocused on good business practices and have been making money to get their companies profitable. We will not white wash this saying everything is great, but the big banks have greatly improved their business practices and their balance sheets. It is the responsibility of the company leadership, board of directors and stock holders to ensure their company is conducting business properly.

The government took another chunk of money and invested in propping up home owners and mortgages. The tax payers will never see that money repaid.

The new Brown-Vitter bill is still in Congress and subject to change from its original form, but the intent is to force big banks to hold up to 15% in capital that would force it to become a cash-holding entity, which would not be able to compete in the finance industry. Or break up the companies to a smaller size. That concept sounds good to many people on the outside, but if we have no big banks, the little or medium size banks could not provide the financing necessary for other large corporations. An example would be if Exxon-Mobile asked for a $500 million loan for exploratory drilling in a foreign country; the banks could not provide the funding for this operations due to the risk.

The initial intent is written to force big banks to get smaller, and eliminate the tag of 'too-big-to-fail.' The requirement of 15% capital reserves would be challenging to raise, and it would take most banks years to raise that much capital for a reserve, and would prevent them from being competitive in the world market with many foreign banks with less restrictive requirements. The measures would also reduce any return on investment for years, which could send stock prices tumbling as investors would move to better returns on their investments. The last consideration may be the most important, as it could trigger the next recession due to reduced lending in the market or higher rates on money. Both of these could slow the economy, that is already struggling.

Our analysis is that the Brown-Vitter bill as it is written today will not become law, but one of three scenarios will play out. The first is Brown-Vitter dies and the laws stays as is for now with some tweaking. The second is Congress or the Federal Reserve/Treasury modify regulations or the Basel III requirements that will have minimal effects and banks help the economy recover. The third is Brown-Vitter is modified to provide clearer regulation and is passed, but not to the aggressive tone written today. It would replace the Dodd-Frank Act and provide additional regulatory requirements. All three scenarios provide important guidance for the industry, but do not create negative effects that harm the economy and the fragile recovery.

We anticipate the U.S. Central Bank to continue buying $85 billion of bonds every month, for at least the next two years, as the economy recovers. There is no sign of inflation, and the government will continue to attempt to hold interest rates down to encourage cheap money for businesses to grow and hire more people.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Collection of the above information came from multiple news sources, and the chart inserted from