Bank stocks in the US – and particularly investment banks – rallied sharply in early February as US President Donald Trump indicated he would push ahead with unwinding some regulation brought in after the financial crisis.
The Center for American Progress has calculated five financial stocks account for more than 40 per cent of the rise in the Dow Jones Industrial Average since November 8th. The jump in Goldman Sachs stock alone accounts for a quarter of the overall rise.
That a president elected to represent the grievances of the lower-middle class would move early to help Wall St might seem counter intuitive – although Wall St is far more densely represented in the Trump team than Pittsburgh – but equally the banks themselves should be wary of the dental work on this gift horse.
Certainly the US regulation, the Dodd-Frank Act, was far from perfect. In order to get it passed in the first place, the Obama administration was forced to negotiate with both its own Democratic members and the Republicans, in the process adding thousands of complexities and extra pages.
The US had not fully joined the international regulatory regime run out of the Bank of International Settlements in Basel before the financial crisis. It is less likely to come on board with a global regime under the current president.
But be aware: US recalcitrance didn’t stop Basel III; it’s unlikely to stop Basel IV. Jurisdictions like Australia, New Zealand and the Asian economies will still base their regulation on the Swiss not the Twitterer-in-Chief.
Moreover, how the US will respond finally – Trump’s executive order drastically reduced protections for consumers receiving investment advice and he believes regulation has held back the economy – is far from certain. It is up to Congress, not the president, to make most of the changes. That’s why Dodd-Frank is so big and complex in the first place.
Like much policy to date under the new government, the latest action is based on anecdata rather than complete analysis or sophisticated modelling.
“We expect to be cutting a lot out of Dodd-Frank because, frankly, I have so many people, friends of mine, that have nice businesses and they can’t borrow money,” was Trump’s explanation.
“They just can’t get any money because the banks just won’t let them borrow because of the rules and regulations in Dodd-Frank.”
Trump’s economic adviser Gary Cohn – one of the Wall St alumni in his inner circle – expanded a little.
“Americans are going to have better choices and Americans are going to have better products because we’re not going to burden the banks with literally hundreds of billions of dollars of regulatory costs every year,” Cohn told The Wall Street Journal, adding the executive order was “a table-setter for a bunch of stuff that is coming”.
The more substantive issue for banks though is not so much whether their operating environment will be easier – and, if so, whether they actually will risk more lending – but whether Trump’s broader economic agenda will deliver growth.
A lower cost of compliance is important but insignificant if US growth starts to wither, international trade flows are staunched, currency wars erupt or the US fiscal position deteriorates to the extent the middle classes are worse off.
While none of these developments are certain they are more likely than what is promised: a sudden return to manufacturing strength, jobs returning to industries now heavily automated, more spending power to people who will have to pay substantially more – due to import penalties – for basic goods at Walmart and a depletion of the animal spirits of innovation due to immigration discrimination.
Trump does have ‘core principles’ for financial regulation and prima facie they’re rational: preventing taxpayer-funded bailouts; fostering economic growth; enabling US companies to be competitive with foreign firms in domestic and foreign markets; advancing American interests in international financial regulatory negotiations and meetings.
The critical issue is whether his policies advance these principles.
One of the most challenging is preventing the kind of taxpayer blackmail that occurred in the financial crisis where catastrophic losses were socialised after decades of profits had been privatised.
This is what Basel and Dodd-Frank are essentially about. Clearly there is debate about their application. There has been a long running debate, with strong arguments on both sides, about whether higher levels of capital have in fact made the system safer and to what degree the imperative to recapitalise has choked off financing of the real economy.
These debates continue.
But what both regulators and the more enlightened industry executives have realised or remembered is black-letter legislation is subordinate to culture. Some of the biggest failures in the crisis satisfied all current regulation and were well capitalised.
Regulators across the world, including in the US, have made the point culture is critical and culture can’t be regulated.
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But far from making it irrelevant in a capitalist system red in tooth and claw, it actually becomes more important. Culture impacts risk, it impacts staff engagement, it impacts customer satisfaction, it impacts the social licence to operate, it impacts the internal communication and cooperation in an institution vital for productivity gains.
In Australia, the heads of both peaks of the regulatory range, Wayne Byres at the Australian Prudential Regulation Authority and Greg Medcraft at the Australian Securities and Investments Commission, have made culture a centrepiece of their actions. The Reserve Bank of Australia too.
Get culture wrong and profitability suffers: there are conduct fines, staff attrition, customer attrition, public and political ire and, eventually, far more onerous regulation.
Critically, culture is set from the top. This then perhaps is the greatest risk if the Trump presidency continues along its current path.
There are grounds for optimism. While Gary Cohn and another key Trump figure Steven Mnuchin are both ex-Goldman Sachs, Goldman’s current chief executive Lloyd Blankfein was one of the first senior business figures to condemn Trump’s anti-Muslim immigration order. Others have followed.
Andrew Cornell is managing editor at BlueNotes
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.