President Trump is focusing early on rolling back regulation, and on Friday he took another good step with directives to peel back Dodd-Frank and the Labor Department’s fiduciary rule. Democrats are predicting another financial crisis, but it’s possible to build a sturdy system that also allows for more risk-taking to serve economic growth.
Start by repealing rules that add costs without making the system safer, such as the fiduciary rule that Labor imposed last year under the guise of protecting savers. The rule requires brokers to act in the “best interest” of clients, though many investors will be harmed. The rule will make investment advice too expensive for many small investors as brokers eliminate commissions and instead charge fees. Plaintiff attorneys are circling, ready to slap brokers with class-action lawsuits if stock prices fall.
Small investors may also find themselves at the mercy of robo advisers that may have a hard time discerning their client’s best interest. Want to know whether to boost your investment in health stocks if ObamaCare is repealed? Ask Alexa. Robert Litan and Hal Singer have estimated that depriving small investors of human advice could cost clients $80 billion in a downturn. Mr. Trump ordered Labor to review and perhaps rewrite the rule that was scheduled to take effect in April.
The President also directed a review of the 2,300-page Dodd-Frank law that has turned banks into regulated utilities. Gary Cohn, who runs Mr. Trump’s National Economic Council, told the Journal that Dodd-Frank’s costs and complexity have restrained bank lending. Democrats wrote Dodd-Frank with enough ambiguity so the feds could regulate as they please. But this means a new government can ease those burdens without Congress.
Take the Financial Stability Oversight Council (FSOC), which has the power to designate “systemically important financial institutions.” SIFIs must comply with onerous regulations but carry an implicit taxpayer guarantee.
Big banks that accept taxpayer-insured deposits are obvious SIFI candidates, but the Obama FSOC also tagged AIG, MetLife and Prudential Financial as SIFIs. These insurers are burdened with bank-style regulations that don’t fit their business model. MetLife sued to rescind the arbitrary designation, and a federal judge has ruled in its favor. The Trump Administration could drop the government’s appeal and settle with MetLife in a way that exempts insurers from the SIFI label.
Also in need of review is the Volcker Rule, which had the sensible goal of barring high-risk trading at taxpayer-insured banks. But regulators needed four years to finalize the abstruse 950-page rule that includes 2,800 footnotes. One iron rule of government is that the more complex a regulation, the easier to find loopholes.
Dodd-Frank’s fatal flaw is assuming that regulators who failed to prevent the last crisis will foresee and prevent the next one. All they need are more rules and more power. But financial manias happen precisely because everyone assumes the good times will last forever.
The better way to prevent a panic is to have simple but firm rules along with high capital standards that make banks better able to endure losses in a downturn. That’s the philosophy behind House Financial Services Chairman Jeb Hensarling’s proposed financial reform, and it’s the direction the Trump Administration should take even without legislation.
But will it? The President signed his directives Friday after meeting with bank executives, and he didn’t help himself politically by praising the “great returns” BlackRock has earned. The point is to help the larger economy, not bank profits.
As a Goldman Sachs alum, Mr. Cohn has a particular burden not merely to relax regulations that are the bane of big banks while doing little to relieve the burden on their smaller competitors and tech start-ups. J.P. Morgan’s Jamie Dimon and Goldman Sachs’s Lloyd Blankfein have argued against a wholesale repeal of Dodd-Frank, which has given these large incumbents a competitive advantage.
Although Mr. Cohn said the U.S. has the highest bank capital standards in the world, they aren’t as high as they should be. The trade he could offer Wall Street is less burdensome regulation in return for higher capital standards. The banks would then be freer to lend money while taxpayers have more protection against the next bailout. This would have the added political benefit of blunting the inevitable Democratic attacks that Messrs. Cohn and Trump are trying to help Wall Street.
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