Taking the Long View: Financial Sector Regulatory Overhaul and the Trump Administration
posted by Marsha Vande Berg on April 19, 2017 - 8:58am
Donald Trump vowed as candidate and newly elected president to “do a number” on Dodd Frank, the sweeping 2010 financial services and consumer regulatory reforms and Dodd Frank’s sidekick, the Volcker Rule. While directives by presidential fiat to Trump’s Treasury Secretary, Steven Mnuchin, and regulators to take initial steps, the congressional action needed to overturn Dodd Frank is far less certain.
Key House Republicans who have championed outright revamping of Dodd Frank and eviscerating the Volcker Rule, plus strictly curtailing the effectiveness of Dodd Frank’s two key oversight bodies, the Financial Services Oversight Council and the Consumer Financial Protection Bureau (CFPB), say the administration’s other priorities will take precedence. An overhaul of the tax code and what Trump boasts as $1 trillion infrastructure spend, now head the legislative agenda.
But even the matter of priorities is not that simple. The healthcare debacle pulled the curtain on disarray both in an inexperienced White House and its relationships with congressional GOP factions, particularly the conservative Freedom faction in the House as well as more moderate Senate Republicans. The disconcerting irony is this is a single political party – the Republicans – control both branches of government for the first time since Ronald Reagan.
By the same token, the implications of stalled regulatory reform for markets and investors are equally unclear. Despite the fact that Trump’s presidential wins since taking office in January have been slim, markets have been buoyed by the potential of the Trump agenda to unleash the American economy’s upside potential. Things are less clear however as to how markets will factor in the geopolitical uncertainties on the Korean peninsula in particular, but also in Syria, Russia and with the war on ISIS in Afghanistan.
Meanwhile, two giants of Wall Street have weighed in decisively and publicly about concerns that the White House will again fall flat with legislative initiatives as House Republicans in particular look toward the biannual elections in 2018. Wall Street has steadfastly supported the so-called Trump trade since Trump’s election, but there are no guarantees despite a rather benign global economy, support for the Federal Reserve to end quantitative easing and raise interest rates, and at least for the time being, the orderly initiation of Brexit.
Larry Fink, CEO of BlackRock, the world’s largest asset manager, spoke to news outlets about the “greater worry” that the White House will successfully move its agenda. Two items are of particular note. First, Trump’s promise to push a multi-billion infrastructure spend faces a big hurdle again with the House’s conservative faction over raising the US debt ceiling, a deadline that looms come April 28. Second, the seemingly endless melodramas within the White House staff included the controversial chief strategist Stephen Bannon growling, “You’re a Democrat” at Jared Kushner, whose responsibilities are increasing steadily at the side of father-in-law.
Jamie Dimon, CEO of JP Morgan, the world’s wealthiest bank, and chair of Trump’s CEO Advisory Council, struck a tone that was different from his prior championing of the Trump agenda in a 45-page letter to bank shareholders that discussed at length the need for a regulatory overhaul ten years on from the 2008-2009 financial crisis. “Something has gone awry,” he said. Bad decision-making is jeopardizing the hard-won confidence that Dodd Frank in the US and similar initiatives globally worked to instill.
Now is the time “open up the rulebook in the light of day and rework the rules and regulations that don’t work well or are unnecessary.” He does not advocate throwing out either Dodd Frank or the Volcker Rule and in fact declares a Dodd-Frank victory in essentially solving Too Big to Fail. Changes in regulation have taken taxpayers off the hook if a bank fails.
At the same time, Dimon’s shareholder missive advances a case for regulatory relief when it comes to capital requirements for both the big money center banks like JP Morgan and the smaller and community banks. Regulation unfairly exposes smaller banks in particular to unaffordable compliance costs – an argument Barney Frank, former Massachusetts House Democrat and an author of Dodd Frank – has said should be reviewed. The big money center banks meanwhile, whose market-making contributes to financial markets’ liquidity are holding back millions of dollars because of their unique capital requirements.
He tenders his disgust with a regulatory environment that is “unnecessarily complex, costly and sometimes confusing.” The Volcker Rule, for example, is enforced by five regulators, leaving banks bewildered about how to answer regulators’ questions about what kinds of trades are too risky and therefore out of bounds under the Volcker Rule. He also weighed in whether some proprietary trades are okay while others too risky” and therefore outlawed under the Volcker Rule. He also weighed in against policy that could reinstate a modified Glass Steagall and divorcing part of the banking function from investments.
To the surprise of many, Gary Cohn, Trump’s chief economic advisor and the former president of Goldman Sachs reportedly told members of the Senate Banking Committee in a private meeting that he supported radically reshaping Wall Street’s biggest firms. While his context was consistent with Trump administration’s view that the banking system should be simplified, it also put him on the side of Massachusetts Senator Elizabeth Warren, a relentless critic of the finance industry and advocate of broad banking sector reform.
These are early steps to set the parameters for regulatory reforms and guide the debate to Trump’s liking and provide policy makers and lobbyists the latitude to raise arguments and opposing perspectives. Two presidential executive orders also make clear Trump’s intention to at least trim current regulations with the potential to in effect deliver “death by a thousand cuts” when it comes to implementation and enforcement of Dodd Frank, the Volcker Rule and the two agencies, set up under Dodd Frank, the Financial Services Oversight Council (FSOC) and the Consumer Finance Protection Bureau (CFPB).
The CFPB arguably has the largest target on its back. Championed by Senator Warren at the time Dodd Frank’s passage, CFPB was set up as a fairly autonomous agency to serve as financial sector consumers’ advocates. Its funding, though capped, is from the Federal Reserve and not Congress. Its director, who serves a five-year term, can only be dismissed for cause. While some on Capitol Hill would place the agency’s governance under a bipartisan commission, a lawsuit pending before the US Court of Appeals in Washington DC, challenges the CFPB’s outright constitutionality. The debate is whether to uphold an unfavorable judicial ruling. Trump’s Justice Secretary Jeff Session has championed findings that there is no check on the director’s actions, including those inconsistent with White House policy interests.
The White House has been explicit about how it expects Treasury Secretary Steven Mnuchin to run the FSOC which he now chairs. The panel, whose members are all the key financial sector watchdogs, is expected to independently apply multiple strands of expertise in its review and tracking of emerging domestic as well as global systemic risks. Its mission is to identify those institutions, including non-banks, such as insurance companies, it deems as “systemically important financial institutions” (SIFIs) and to place those institutions under the Federal Reserve’s scrutiny.
In the case on non-banks Dodd Frank and Volcker Rule supporters argued in favor of extending SIFI oversight to institutions that fall outside the classic definition of a bank because they are critical to market liquidity. While Trump has directed and ten GOP Senate Republicans have petitioned Mnuchin to consider dropping non-banks for the SIFI review.
The FSOC has designated four non-banking institutions as SIFIs, including American International Corporation and Prudential Financial. A decision to drop the designation would likely release these two institutions. A third, GE Capital, sold parts of its business since it received the designation and thus reversed the order, and a fourth, Metlife, has sued successfully to remove its “too big to fail” designation. That decision is now pending an appeal.
Dimon’s shareholder letter favors streamlining the overall regulatory system and a radical reduction in the number of regulators to a single regulator. At the same time, he advocates testing existing rules for consistency, transparency, whether they are risk-based ad not punitive and overall simplicity. He also argues for strengthening – not weakening FSOC, giving it the necessary authority to assign responsibility, adjudicate disagreements, set deadlines and force resolution of critical issues.
His advocacy of reduced capital demand requirements’ “too high price tags” for banks is central to his position, although he devotes little space to the Volcker Rule. Named for the former head of the Federal Reserve, Paul Volcker, the rule’s chief priority is to lower the overall risk levels of banks trading on their own account and limiting banks’ investment in private equity or hedge funds, so-called covered funds. Its implementation a full three years after Congress passed Dodd Frank, was then treated with something like a shrug by Wall Street, where banks had preemptively spun off their proprietary trading platforms. Goldman Sachs, for example, sold its platform to KKR.
The Rule’s inherent difficulties were apparent at the start of its implementation. Five regulators would oversee its enforcement. Advocates also want the rule to do a better job in spelling out when a risky trade is too risky and thus triggers application of the Rule.
Changes within regulators’ purview and affecting enforcement and implementation reflect the wide latitude a president has in shaping rule promulgation and implementation – except in the case of independent regulators such as the SEC. But even here, presidential appointees will have latitude to ensure their actions are consistent with White House directives although short of any court challenge.
The two Trump directives in the form of presidential executive orders were clear about Trump’s intent albeit short on specifics. Within weeks of taking the oath, Trump hissed the first of two Dodd Frank related executive orders. The first, dated Jan. 30, called on regulatory agencies to eliminate two regulations for every new one they issue – and to ensure the cost of regulations be “prudently managed and controlled through the budgeting process.” The White House later clarified that this order would apply to agencies other than those with statutory independence.
In his second directive, Trump extends the cost-benefit requirement by laying down “core principles for regulating the US financial system.” Dated Feb. 3, the order includes seven principles focusing on efficiency, effectiveness and “appropriate tailoring.” Trump also told Mnuchin to make sure his work with FSOC was consistent with these core principles.
The White House-ordered review may also affect mortgage regulations as well as the governance of Fannie Mae and Freddie Mac. Other rules at risk of alteration and even demise include the SEC’s conflict minerals disclosure rule requiring that companies be transparent about their overseas mining operations. Various corporate governance rules may likewise be trimmed, including Dodd Frank requirements that public companies disclose the ratio between their CEO’s compensation and the median compensation of employees.
The very complexity of US financial services regulatory regimes itself leaves implementation and enforcement wide open as to specifics of interpretation about what is consistent with White House edicts. It is clear, however, that the Trump White House intends to tie rule promulgation and implementation to costs versus the benefits. The risk here is that in undoing Obama era regulatory reform, policy makers and regulators jeopardize the very public confidence Dodd Frank sought to re-instill in the sector and to prevent another crisis like the one that brought the US economy to its knees.
Dodd Frank was a response to broken public confidence – and to the increasingly complexity of the sector itself with its intricacies of proliferating asset classes, some regulated, some not, and the global interconnectivity of big money center banks in particular. It seems a very long time ago but it was 2011 when Occupy Wall Street first organized in a park near Wall Street and railed against these excesses and with them, increasing income inequality between the 1 percent and the rest. That movement caught fire nationally and then globally.
Dodd Frank and the Volcker Rule were also not a case of America going solo. US policymakers and regulators were working with the UK and the rest of the G20 regulators. The Systemic Risk Council, a global group of former financial regulators and academics recently issued a statement that warned against wholesale financial deregulation, arguing that the world has changed and that financial institutions remain at heightened risk of financial losses during an economic downtown. Post-crisis reforms are still vital and should continue. Debt levels in the global economy continue to climb and going forward central banks and fiscal policies will not have nearly the “firepower” they were able to deploy in 2009.
The higher capital demands on all regulated financial institutions and even higher equity requirements for the largest and most complex financial intermediaries ought to be extended, not curbed to constrain liquidity risks in shadow banks, the so-called nonbanks but which participate in credit making. Instead of diluting their work, regulators should “err on the side of caution in requiring equity levels that will prove prudent when the next downturn arrives given the persistent overhang of debt,” said the report signed by the Council’s membership and its leadership, including Volcker, Sheila Bair, former FDIC chair, Jean-Claude Trichet, former European Central Bank president, and Sir Paul Tucker, former Bank of England deputy governor.
There is no “end game” when it comes to protecting confidence in the financial sector. The Trump administration, like the administrations before it, will be called to account as to whether they lived up to the trust placed in them, not to mention their own political hype.