Days ago, President Donald Trump vowed to do a “big number on Dodd Frank,” the sweeping banking legislation put in place by the administration of President Barack Obama in response to the 2008 financial crisis. Trump called Dodd Frank “a disaster” that has impeded growth by making it harder for banks to lend to consumers and small businesses. Still in his second week in office, Trump is making good on his statement.
On Friday, the Trump administration will sign an executive order to dramatically scale back Dodd Frank. The Act, signed into law in 2010, re-shaped Wall Street and the American banking industry.
For America’s largest banks, it forced firms to undergo a host of new regulatory exams and pare back their lucrative but illiquid private equity and hedge fund investments. Some mid-sized banks felt the weight of Dodd Frank, as firms with over $10 billion in assets and $50 billion in assets were subjected to increased surveillance.
The Act also created new regulatory agencies such as a Financial Stability Oversight Council (FSOC), which aimed to resolve failing large firms, for instance another Lehman Brothers, without a government bailout or next crisis. It also spawned the Consumer Finance Protection Bureau, an agency dedicated to guarding against abusive or misleading retail financial products.
This regulatory regime, however, is now about to be re-written, if not unwound entirely.
Trump’s executive order will mandate sweeping change to current law and, if successful, could eventually lead to a replacement. “We’re going to be doing a big number on Dodd-Frank,” Trump said on Jan. 30. “Dodd-Frank is a disaster.”
In an interview with the Wall Street Journal, Trump’s White House National Economic Council Director Gary Cohn said the order will direct the U.S. Treasury to revise Dodd Frank. “We have the best, most highly capitalized banks in the world, and we should use that to our competitive advantage,” Cohn told the WSJ. “But on the flip side, we also have the most highly regulated, overburdened banks in the world,” he added.
Trump’s executive order “is a table setter for a bunch of stuff that is coming,” said Cohn, who recently left investment bank Goldman Sachs, where he was second in command to CEO Lloyd Blankfein for a decade.
The biggest areas of focus are likely to surround the FSOC, which Cohn said had not succeeded in building a system to resolve a failing bank without either government aid, or posing a risk to the financial system writ large.
Say Goodbye To The Volcker Rule
Other areas of early focus will surround the Volcker Rule, a mandate named after former Federal Reserve chair Paul Volcker, which restricted banks from proprietary trading and limited their ability to make hedge fund and private equity investments. Trump’s Treasury Secretary nominee Steven Mnuchin, another former Goldman partner, has said he would look to repeal the rule.
While aimed at limiting risk on Wall Street, especially in the opaque and leveraged areas of capital markets that made the credit crisis so violent, the Volcker Rule led to enormous backlash.
Investors and bank chieftains complained that it never truly defined the difference between proprietary trading and market making, where trading firms hold out bids and offers across financial markets and hold short term inventories of assets to accommodate transactions. As a consequence, many banks simply stepped back from making markets, creating illiquidity that investors believe has exacerbated price swings, particularly in less liquid assets like junk bonds and leveraged loans. Undoing the rule would have dramatic ramifications on Wall Street.
Going back to old trading standards would likely gin the operations of America’s largest banks such as Cohn’s former employer Goldman Sachs, JPMorgan, Bank of America, Morgan Stanley and Citigroup. Moreover, it might begin to turn a dramatic shift in the balance of power on Wall Street. Due to the Volcker Rule, some of the best investing talent fled hamstrung brokerages for less regulated entities such as hedge funds and private equity firms.
The years since the crisis allowed private equity firms like Blackstone, Apollo, KKR and Carlyle to expand in businesses like real estate investing, where investment banks once were forceful competitors, and it all but exited firms from the leveraged buyout business. Goldman Sachs and Morgan Stanley were once the breeding ground for quantitative traders such as Citadel’s Ken Griffin, AQR’s Cliff Asness and PDT Partners’ Peter Muller, but these types of operations were shuttered entirely, or spun out.
Although Dodd Frank restrictions led to a malaise on Wall Street, it also meant the years since the crisis were marked with stability and minimal volatility.
When oil prices plunged two years ago, no major investment bank was saddled with large losses. The same holds true for recent freezes in speculative grade credit, or volatility in currencies. As bouts of financial contagion spread in Europe in recent years, investors have never felt the tumult would jeopardize any major Wall Street firm because of their years of retaining profits to rebuild capital.
Trump’s Main Street Financial Overhaul
Change to Dodd Frank won’t just impact the highest rungs of finance. Since Trump was elected, banking industry trade associations have lobbied for a rollback of oversight on smaller lenders.
Presently, banks exceeding $10 billion in assets are subjected to increased oversight, and those with $50 billion in assets can be deemed a systemically important financial institution and put under exams administered by the Federal Reserve such as stress tests. A day after the election, Tom Michaud, CEO of financial sector investment bank Keefe, Bruyette & Woods told FORBES he’d like to see an increase of SiFi designations to just banks with $250 billion in assets and above.
Such relief might have a potent impact on Main Street because it would dramatically reduce overhead costs for small and mid-sized lenders, potentially giving them greater financial flexibility to make small business and consumer loans. More broadly, bank CEOs like JPMorgan’s Jamie Dimon have said regulatory relief could increase the flow of money into the broader economy.
“I do think if there’s some regulatory relief, you will see banks be more aggressive and growing, opening branches in new cities, adding to loan portfolios, seeking out clients they don’t have. So I’m hoping that we’ll see a little bit of that too, but that will wait for a little regulatory relief,” Dimon told investors on Jan. 13.
Said Cohn of the looming change, “it has nothing to do with J.P. Morgan, it has nothing to do with Citigroup. It has nothing to do with Bank of America. It has to do with being a player in a global market where we should, could and will have a dominant position as long as we don’t regulate ourselves out of that.”
Trump’s executive order will also unwind a mandate imposed by the Department of Labor called the fiduciary rule, which seeks to hold investment advisers to a standard of acting in their clients best interests. This rule, set to go in effect in April, will be repealed, Cohn said, because it will limit consumer choice.
Consumer Protection Agencies On The Chopping Block
Finally, it appears the Trump administration will seek to replace CFPB head Richard Cordray, in a first step towards neutralizing the regulatory agency.
Only months ago, the CFPB led an investigation into Wells Fargo that revealed the bank had created thousands of fake savings and credit card accounts without the consent of consumers. When employees raised their voices against these practices, they were fired. The scandal rocked Wells Fargo, leading to the quick resignation of CEO John Stumpf, and it spawned a host of regulatory investigations.
The CFPB has also played prominently in combating usury, improper foreclosure practices, and payday loans that can leave the poor under a mountain of debt. The Trump administration, however, feels the CFPB has over-reached and made businesses hesitant to grow.
Cohn further hinted that he and Treasury Secretary Mnchin are prepared to overhaul Fannie Mae and Freddie Mac, two housing agencies that guarantee the vast majority of prime mortgages in the United States but were put into government conservatorship in 2008.
“I’m not sitting here saying we want to go back to the good old days,” Cohn told the WSJ of the planned overhaul. He said the Trump administration could write better, more efficient regulations and also expressed confidence that the market – smarter from the lessons of the crisis – would be able to regulate itself as restrictions were loosened.
Democrats will fight Trump’s executive order, and it is too be seen whether a rollback will be so easy to pull off. Even in the wake of a severe crisis that germinated from Wall Street, it took years of battle to sign Dodd Frank into law.