New reports on Friday confirm President Trump is taking steps to roll back the Dodd-Frank act, the crux of expanded regulations designed to prevent another 2008-style systemic banking crisis.
Gary Cohn, director of the White House National Economic Council told the Wall Street Journal:
“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.”
Since Dodd Frank was introduced, banks have devoted a lot more capital towards compliance and have had to decrease leverage, both of which are a direct hit to profitability. If Dodd-Frank is watered down, that’s a direct boost to the bottom line for banks. Barclays (LON:BARC) and RBS (LON:RBS) are top of the FTSE 100 and we expect even bigger gains for the money-centre banks, including Goldman Sachs (NYSE:GS) when Wall Street opens later.
The changes to Dodd Frank are likely to small to begin with but Trump is shifting the direction of travel from more regulation to less regulation. That’s a good thing for the financial sector, and potentially corporate America as a whole. US stocks have turned lower in the last couple of weeks as Trump focused more on trade tariffs for the auto sector and penalising healthcare companies over drug prices. Trump turning his attention to deregulation could be just the boost Wall Street needs to send the Dow back above the 20,000 mark.
It is not unreasonable to question the one-sided viewpoint of Cohn, who just quit his position as President of Goldman Sachs, potentially one of the biggest beneficiaries of banking deregulation. Trump was heavily critical of Wall Street during his campaign and said he wanted to “drain the swap”. Trump is on slippery ground here, he risks losing grassroots support if he’s seen as going back on his campaign promises. Trump needs public opinion behind him to enable more executive orders. If his hands start to get tied by falling public support for his agenda of tax cuts and infrastructure spending then the enthusiasm in the stock market could turn sour.
Still, it is a mistake to view Dodd Frank as completely positive; there were some unintended consequences. Part of the course of the financial crisis was too much power concentrated within big banks who took oversized risks that the public had to bail out when they went bad. Dodd Frank, by burdening small community lenders with huge regulations has exacerbated the trend of consolidation in the US banking sector. Minneapolis Federal Reserve research suggests that adding two members to the compliance department would make a third of the smallest US banks unprofitable. Too much regulation favours the large institutions who can afford the extra compliance costs.
Unwinding some of Dodd Frank is a good thing because it will enable smaller community banks to compete, offering competition to consumers. Repealing too much of Dodd Frank puts the entire system at risk of a repeat of 2008. The red line is the Volker rule; if the big banks can engage in proprietary trading, then depositors will be put at much greater risk. The Donald has a difficult balancing act.