US President Donald Trump signed an Executive Order on 3rd February 2017 to review the 2010 Dodd-Frank financial regulations, which were brought in to prevent another 2008 financial crisis. Simon French, Panmure Gordon’s chief economist, explains that “The Executive Order is more a set of principles to guide deregulation efforts. However recent testimony from senior Trump officials have suggested that legislation will look to revoke the ring-fencing of retail assets (deposits), which can no longer be used as collateral for investment activities – the so called Volcker Rule.”
Trump’s 7 principles
According to a White House media release about the Presidential Executive Order on Core Principles for Regulating the United States Financial System, there are seven principles at the heart of the new order, and they are the following:
- To empower Americans to make independent financial decisions and informed choices in the marketplace, save for retirement, and build individual wealth;
- To prevent taxpayer-funded bailouts;
- To foster economic growth and vibrant financial markets through more rigorous regulatory impact analysis that addresses systemic risk and market failures, such as moral hazard and information asymmetry;
- To enable American companies to be competitive with foreign firms in domestic and foreign markets;
- To advance American interests in international financial regulatory negotiations and meetings;
- To make regulation efficient, effective, and appropriately tailored; and
- To restore public accountability within federal financial regulatory agencies and rationalise the Federal financial regulatory framework.
The move could force UK and European regulators, even before Brexit has been completed, to relax their own regulatory environment. City AM reports that the prospect of the relaxation of the rules led to bank share soaring. Morgan Stanley’s share prices, for example, rose by 5% in early February 2017. Shares in CitiGroup and Bank of America also benefited from the news. Back across this side of the pond in the UK, banks with interests in the States also rose. For example, Barclays saw its share price jump by 4%. Shares in Lloyds, Royal Bank of Scotland and HSBC also rose.
Simon French, Panmure Gordon’s chief economist, describes the repeal of Dodd Frank as beggar-thy-neighbour economics because the relaxing of Dodd Frank would only benefit the US at the expense of other countries. He argues that it means that British and European banks have to face the prospect that their marginal costs will increase if they decide to stick with the Basel protocols and other international standards. Meanwhile, doing business in the US will reduce. He therefore thinks that the banks’ stock leapt in anticipation that de-regulation is around the corner – following suit with any relaxation of the current Dodd-Frank regulations in the US.
He adds: “The repeal of that would give US banks more effective capital than European banks (if it were to pass)”. In his view this raises the question of what kind of behavioural response will be expected by the European banks. “If the US rolls some regulations back, then one country within global finance is starting to compete on regulation – an area of consensus since the Global Financial Crisis”, he explains before suggesting that there are “parallels with the recent currency wars where everyone else is forced to also compete in a race to devalue their currencies.”
This can lead to economic activity shifting from one geographic region to another: from the more expensive market to the less expensive market. “Deregulation of financial services is analogous to Trump talking down the US dollar because it is about making the US more competitive than its neighbour either through currency, regulation or tax”, he says. In other words it is the manifestation of an “America First” policy to ensure that the US either maintains or regains a dominant position.
To remain competitive he thinks that British and European banks will potentially need to follow suit by seeking to reduce the amount of regulations they are required to comply with. This may become essential to prevent businesses shifting to locations such as New York. Given the backlash that has occurred against the banks since the global financial crisis a reduction in regulation is unlikely to gain the support of public opinion. The governments within the region, as well as across the globe, may also not support a more relaxed regulatory framework. They may still be forced to act to ensure that their banks and financial service markets remain competitive and profitable.
Questions also have to be asked why regulatory reform is necessary given that the regulations that have been in place since the 2008 financial crisis have largely been viewed as being successful. “On the basis that we haven’t had another financial crisis since 2008 they have been successful”, he discloses. “However financial crises only tend to occur every 50-70 years, so it remains premature to assess whether Dodd Frank has been successful”, he adds before suggesting that regular stress testing of the central banks against various scenarios can only determine their success over time.
“The systemically important institutions have more tier 1 capital than they did going into the financial crisis, and the Basel process has been the vehicle for having higher capital requirements, and if the US pull out of this multilateral standard then the amount of capital kept by US banks could be reduced”, he comments. He says the argument is that without Dodd Frank you can free up lending and then the economy will grow faster. This will be an attractive prospect for the President and many in Congress, and yet he explains that for the moment “Congress are working out whether they want to take an America first approach or a multi-national approach to regulation“.
Regulation: Gone too far?
French explains that President Trump thinks that regulation has gone too far, making US banks uncompetitive in that regulation has restricted lending. His supporters feel that there is insufficient credit available to set up businesses. French cynically suggests that repealing Dodd Frank might not benefit his supporters. While it is viewed by Trump’s proponents that debt will become cheaper as a result of repealing it – and Trump has used debt finance to further his business empire, he questions whether the Executive Order will benefit his electorate.
French therefore concludes: “In reality it enables real estate companies and financiers to make more money, and they are a different cohort of people to the one’s he’s trying to justify the changes to Dodd Frank.” The risks of repealing Dodd Frank may in the long run outweigh the short-term political and financial benefits too. French feels that its reform may lead to a race to the bottom because other countries and economic regions will be forced to follow suit. He therefore fears that this will lead to uncooperative actions, higher macroeconomic risk and increased protectionism.
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