Trump’s Dodd-Frank haircut could be little more than a trim

After Donald Trump was elected in November, he announced that he would “do a number” on the Dodd-Frank Wall Street Reform and Consumer Protection Act passed by the previous administration in 2010. 

On February 3, the US president announced a four-month review of the regulation that was light on detail but produced significant political benefit after chief economic adviser Gary Cohn was drafted in to publicise it.

The Financial Stability Oversight Council (FSOC) was instructed to report back in 120 days on whether the current regulatory system met the administration’s eight core principles.

Two months later, Trump was still threatening to do something to Dodd-Frank, but this time it was a haircut rather than a number. 

“We’re going to be coming out with some very strong – far beyond recommendations – we’re going to be doing things that are going to be very good for the banking industry so that the banks can loan money to people who need it,” he declared on Tuesday. 

“We’re going to do a very major haircut on Dodd-Frank. We want strong restrictions, we want strong regulation. But not regulation that makes it impossible for the banks to loan to people that are going to create jobs.” 

In his letter to shareholders, posted on the same day, Jamie Dimon, the chief executive of JPMorgan, could have been writing straight to Trump with his claim that “the removal of the GSIB [global systemically important banks] surcharge ‘gold plating’ alone would free up $15 billion of equity capital – an amount that could support almost $190 billion of loans.” 

Indeed, when Trump announced his regulatory review in February, he memorably purred: “There is nobody better to tell me about Dodd-Frank than Jamie.”

Despite the rhetoric, the expectation in the banking industry is that little will actually happen in legislation even after this review. Any proposed changes will have to go through both the House of Representatives and the Senate will likely be filibustered to death. 

Following his bruising experience with healthcare reform, Trump might now pick his legislative targets carefully. 

The US public quite likes Dodd-Frank. Aside from the core Republican base, the view among voters seems to be that if Wall Street blew up the world once then it is probably quite a good idea to have legislation in place to stop that happening again. 

Democrats are, therefore, not afraid to defend Dodd-Frank and it is not a high enough priority for the Trump administration, which is focused on healthcare, tax reform and immigration.

There will, however, be change. The template through which Dodd-Frank will be tinkered with is the Financial Choice Act, which is being promoted by Jeb Hensarling, chairman of the House Financial Services Committee. This would essentially scrap Basel and Dodd-Frank capital ratios and rely on a 10% leverage ratio to regulate the banks. 

Such a change would make US banks essentially unregulated from a European point of view and their non-US based activities would therefore have to submit to European regulation at group level. 

That would blow a hole in what is left of transatlantic regulatory cooperation. US representatives on the Basel Committee will likely already be working to make sure that nothing much happens that is not purely technical. Without US participation, the Committee is hobbled: Europeans are unlikely to push something that is binding on their banks, but not their US competitors. 

There will, however, still be US support for Basel IV as this will push up capital demands for European banks rather than US ones.  

Despite the focus on Dodd-Frank’s Volcker Rule, this will likely remain in law as it polls very highly with the public. What will change, however, is its implementation and a lot of the flexibility around this could be scaled back. Stress tests might become simpler and the implications of failing them less severe.

Another primary point of contention amongst Republicans with regard to Dodd-Frank is Title II, which provides for the orderly liquidation of a failing systemically important bank (SIB) by appointing the Federal Deposit Insurance Corporation as receiver. As such, it sets up a mechanism for using taxpayer funding to support a failing bank – an anathema to many. 

However, replacing Title II with Chapter 14 amendments to the US banking code will inevitably slow down any SIB resolution process. Bankruptcy judges are prevented from any discussion of a case in advance, and also cannot deliver a final verdict without having heard all parties. This means that a swift resolution over a weekend would be impossible. 

Dimon makes the claim that too-big-to-fail has been solved, but many feel that the loss of Title II could make a government bailout of an SIB an inevitability, simply because the alternative would take too long. 

Any changes to bankruptcy law have to go through both House and Senate judiciary committees, but getting rid of Title II is nevertheless seen as likely to happen. As one bankruptcy expert observes, if it does, non-US regulators will “electrify the ringfences” around US intermediate holding companies in their home regions. 

An easy win for Trump would be to increase the size at which a bank is deemed to be systemically important. This might move from its current level of $50 billion assets to as much as $150 billion to $200 billion assets and would release many US lenders from the additional buffers that SIB status imposes. 

The US banking industry will find out just how much of a haircut their oversight is in for when the FSOC reports back in June. Daniel Tarullo resigned as head of financial supervision at the Federal Reserve with effect from Wednesday and his replacement in this crucial position for financial regulation is still unknown. This will likely delay the review’s findings. 

US banks hoping for a bonfire of regulation from the Trump administration might be disappointed. 

“There is a difference between a deregulatory mindset and deregulation,” points out one veteran lawyer. “I don’t believe in deregulation: I have worked in financial regulation my entire life and I can’t remember ever having seen any. Regulators just replace one set of rules with another.”