Make the rules simpler, by all means. But not at the expense of safety
THE prospect of deregulation helps explain why, since Donald Trump’s election, no bit of the American stockmarket has done better than financial firms. On February 3rd their shares climbed again as Mr Trump signed an executive order asking the Treasury to conduct a 120-day review of America’s financial regulations, including the Dodd-Frank act put in place after the financial crisis of 2007-08, to assess whether these rules meet a set of “core principles”.
To critics of Dodd-Frank, this is thrilling stuff. They see the law as a piece of statist overreach that throttles the American economy. Plenty in the Trump administration would love to gut it. The president himself has called it a “disaster”. Gary Cohn, until recently one of the leaders of Goldman Sachs, a big bank, and now Mr Trump’s chief economic adviser, promises to “attack all aspects of Dodd-Frank”.
Opponents of moves to unwind regulation are as apocalyptic. Wall Street caused the crisis, they observe; undoing Dodd-Frank would lead to the next disaster by letting bankers run riot again. That would harm customers and taxpayers, as would suspending the introduction of the fiduciary rule, another Obama-era regulation requiring financial advisers to act in clients’ best interests. A demand that America stop co-operating with international regulators, issued to the Federal Reserve by Patrick McHenry, a Republican congressman, is a sign of the growing pressure for the wrong sort of deregulation.
It would be hard for the Trump administration to get a full repeal of Dodd-Frank through Congress (see article). But his team could still change an awful lot—for good or ill. Their goal should be to simplify America’s financial rule book, without softening its force.
Dodd and buried
When it was passed in 2010 Dodd-Frank was a monster of a law and was programmed to spawn more regulations. It imposed more than five times as many restrictions as any other law passed by the Obama administration. More constraints were added to the federal banking code between 2010 and 2014 than existed in 1980.
As the clauses multiplied, so did the compliance burden on banks. Between 2010 and 2016, Dodd-Frank soaked up 73m paperwork hours and $36bn in costs. The big banks complain, but they have the heft to cope. The financial implications are worse for small lenders. A study by the Minneapolis Federal Reserve found that adding two extra members to their compliance departments tips a third of small banks into the red.
Onerous though it is, however, the act also achieved a lot. Measures to beef up banks’ equity funding have made America’s financial system more secure. The six largest bank-holding companies in America had equity funding of less than 8% in 2007; since 2010 that figure has stood at 12-14%. Rules to increase the transparency and safety of derivatives markets were welcome; so, too, were rules to make it easier to wind down a failing bank. And despite concerns that the country’s big banks are disadvantaged internationally, they rule the roost of global finance: the top five banks in the investment-banking league tables in 2016 were all American. Indeed, few things would more quickly undermine these institutions abroad than a decision to stop playing by international rules.
How, then, to keep the good and get rid of the bad? First and foremost, avoid backsliding on capital requirements. The surest way to cope with a financial crisis is for banks to have lots of equity funding. Separate proposals from Jeb Hensarling, another Republican congressman, and Tom Hoenig, the vice-chairman of the Federal Deposit Insurance Corporation, offer regulatory relief only to lenders that meet a very high capital bar. That is the direction to take.
Next, unravel the sprawl. Consolidating America’s overlapping financial agencies into fewer regulators would be a boon for everyone except their staff. So too would adopting principles-based regulation to replace detailed prescriptions that add to compliance costs but not to stability or efficiency. The Volcker rule, for example, could have been distilled to a simple principle of “not conducting proprietary trading”; instead it ended up taking up almost 300 pages to define. It is a similar story with the fiduciary rule—a fine principle bogged down in overprescription.
Third, require greater accountability of financial regulators. When they levy fines or label an institution as systemically important or fail institutions on stress tests, regulators should have to explain their reasoning, so that everybody is clear about what counts as acceptable behaviour. The Consumer Financial Protection Bureau is one agency that deserves to survive, but the unusually mighty powers of its director should be pared back and its funding should come from Congress rather than the Federal Reserve.
As ever with Mr Trump’s nascent administration, it is hard to know what lies ahead—and easy to be fearful. But a sensible approach to reform would look something like this: keep capital high and rules simple. Judge what comes from Mr Cohn’s assault on regulation by that standard.
This article appeared in the Leaders section of the print edition under the headline "The litter of the law"
