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In early February, US president Donald Trump signed an executive order requiring the Treasury department to ensure that financial regulation accords with the president’s new core principles.
The principles of ‘America first’, rather than global financial system stability, suddenly now dictate the approach to bank regulation. US bank stocks shot up in expectation that executives will begin to return to investors much of what they have described as an excess of capital held only to satisfy over-zealous regulators.
Gary Cohn, former second in command at Goldman Sachs – a firm kept alive in the financial crisis only by the taxpayer-funded bailout of AIG and its own swift re-characterizing by regulators as a bank – is now director of the National Economic Council. The NEC is making the case for cutting the burden of bank regulation on the basis of promoting growth and job creation. Cohn casts regulation as an inhibitor of both.
Surrounded by giants of US finance and declaring his intention to cut a lot of Dodd-Frank rules that have stopped banks lending money to his friends and their nice businesses, Trump looked like a befuddled farmer so concerned for his flock that he has invited the grinning wolves round to redesign security on his sheepcote.
While the imagery around the Trump presidency looks awful, it may obscure some good intentions.
Hugely complex
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 is a vast patchwork of legislation that has proved hugely complex to put into effect. The instinct to review its cumulative impact, in addition to the many other regulatory changes introduced since the financial crisis, is a sound one.
To take one obvious example: the founding notion of the Volcker rule to cast banks as agents to their customers rather than principal counterparts and competitors is clearly well intentioned. But its implementation has had outcomes that now are well worth revisiting. Credit intermediation in the US flows through the capital markets. Has the withdrawal of bank capital to take short-term proprietary positions in an increasingly illiquid Treasury bond market weakened a key underpinning of those markets?
Cohn was critical of the onerous and byzantine requirements imposed on banks to create living wills. Euromoney has always been sceptical that the existence of these wills makes big banks any less of a contingent liability of the sovereign.
There is plenty in the legislative regulatory response to the crisis that looks like a well-intentioned distraction from the real task. Instead of only insisting banks carry enough capital and liquidity to survive the next inevitable downturn, more effort should have gone into ensuring banks are good risk managers, equipped with fit-for-purpose technology that can provide real-time data on aggregate risk exposures, supervised by directors with the right expertise.
So, let us encourage the new administration on this mission to review the regulations on banks, to test their efficacy and, where possible, simplify them and make them easier to implement and enforce.
What stops us cheerleading this effort, however, is the worry that it springs from misguided motives. Has an excess of bank regulation really impeded economic recovery and job creation in the US? Has an excess of regulatory capital honestly prevented lenders from pricing affordable loans suitable to US customers with the cash flow, collateral and character to service them? The answer is no.
Nonsensical claim
The other false note from the chorus now proclaiming the urgent need for deregulation is the nonsensical claim that rules agreed in secretive forums by global bureaucrats in foreign lands have somehow unfairly penalized US banks and put them at a disadvantage.
This looks like the all-time, prize-winning ‘alternative fact’. It is the opposite of the truth. Foreign banks are a much-reduced force in the US, while US banks dominate in many of the most keenly contested areas of international wholesale banking.
It looks as if what is being unleashed now is not the judicious ironing out of the unintended consequences of essential new rules needed to rein in a banking industry that had gone rogue in the run-up to the crisis – rather it might be a reckless new era of competitive deregulation. If the US government, encouraged by members with strong ties to the banking industry, now intends to strike home the advantage in a sector where US banks are already winning handsomely, the outcome might be both surprising and unhealthy for the global economy. The Europeans would surely fight back.
If an increasingly protectionist political ideology takes hold on both sides of the Atlantic, no one knows what the further balkanization of banking will do for the world economy, but it probably won’t be good.
A race to the regulatory bottom in banking will all but guarantee another financial system breakdown, possibly quite soon.