The mood in the room was decidedly chummy. U.S. President Donald Trump had invited the heads of America’s biggest financial institutions to the White House to discuss no less than the future of Wall Street. Speaking about Jamie Dimon, head of JP Morgan, President Trump was all compliments. “No one can tell me more about Dodd-Frank than Jamie,” he said, according to the New York Times.
Dodd-Frank is the name of a wide-ranging law passed under the Obama administration after the 2008 financial crisis with the goal of preventing similar disasters. According to Mr. Trump and the Republican Party, the legislation, which was signed into law in 2010, has become an enormous burden on the U.S. economy.
This is why the new president on Friday signed an executive action ordering a review of the regulatory system. It has been widely perceived to be setting the groundwork for repealing the contested law. While Mr. Trump's executive order is vague, it emphasizes the "core principles" of strengthening American investors and offering the U.S. a competitive edge for international investment.
After the 2008 crisis, politicians and regulatory watchdogs around the world took action to fight against the excesses of the banks. At a G20 meeting in Washington, the political leaders of 20 major economies swore to work together to reform the financial industry and set international minimum standards.
Now the worry is that the international consensus on reform is gone – and that more tightly-regulated European banks could be put at a disadvantage.
It’s not going to happen overnight, but we are likely to see a clear reduction in regulation in the U.S. over the next few years. Isabel Schnabel, German economist
German economist and government advisor Isabel Schnabel is among those predicting a global race toward deregulation, which she fears would undermine the stability of the international financial system.
“It’s not going to happen overnight, but we are likely to see a clear reduction in regulation in the U.S. over the next few years," Ms. Schnabel, a member of the German government's Council of Economic Experts, said in an interview with Handelsblatt. “This also would have a spillover effect on the rest of the world.”
Andres Prescher, a legal expert on derivatives and regulation compliance at KPMG Law, is equally concerned. “Without a key player like the U.S., and given the high mobility of financial services, maintaining the existing level of regulation will be difficult,” he said.
In the United States, critics also see the danger that deregulated banks could pose for the global economy. Janet Yellen, the current head of the U.S. Federal Reserve, America’s central bank known as the Fed, recently warned against crippling financial oversight mechanisms. Jeromin Zettelmeyer of the Peterson Institute for International Economics in Washington fears a "new credit boom, a new bubble."
European banks are now worried that their competitive weakness with U.S. banks – previously minimized by the post-crisis reforms – will now only grow with deregulation. Michael Kemmer, head of the Association of German Banks warned that “a competition for the most lax supervision does not help anyone.”
Ms. Schnabel is similarly worried that this could quickly become a race to the bottom in terms of regulatory ethics.
“Deregulation is increasingly being used by governments to strengthen the competitiveness of their own domestic entities,” she said. “This is very harmful and threatens the stability of the financial system.”
It's a concern that is being voiced in the United States itself as well: “The biggest danger is that we turn our backs on international cooperation,” said Edwin Truman, a senior fellow at the Peterson Institute and former assistant secretary of the U.S. Treasury under Bill Clinton.
President Trump's recent overtures toward Wall Street have done little to assuage these fears, and he may also be getting help from the Republican-led U.S. Congress.
This past week, Congressman Patrick T. McHenry, vice chairman of the House Financial Services Committee, sent a letter to Ms. Yellen demanding that the Fed “cease all attempts to negotiate binding standards burdening American business until President Trump has had an opportunity to nominate and appoint officials that prioritize America’s best interests.”
Mr. McHenry is specifically eyeing the new, stricter global banking rules known as Basel IV, the latest update to a series of changes meant to form the cornerstone of reforms after the financial crisis, providing a global standard on capital reserves for banks. But the question of how banks were supposed to calculate their risks in the future had already led to disagreement between the United States and Europe. Now, economic experts like Ms. Schnabel are wondering if any sort of compromise is still possible.
Gary Cohn, who recently left Goldman Sachs to become an adviser to President Trump, and Steve Mnuchin, another former Goldman Sachs executive and current nominee for secretary of the treasury, will also help set the deregulation agenda. Friday’s executive action calling for a review of Dodd-Frank was joined by another order calling for a review of a Department of Labor fiduciary rule requiring financial advisers to act in the best interests of their clients.
Of course, Mr. Trump cannot rule by decree alone and most supervisory authorities, including the Fed, are not bound by these directives from the White House. However, Mr. Trump does decide who runs these authorities – Ms. Yellen’s term will be up in January 2018. German Finance Minister Wolfgang Schäuble has already expressed his concern about her successor: The European Central Bank is independent, he said, and he hopes that the Fed will remain independent as well.
Statements by Mr. Trump, Mr. Mnuchin and Mr. Cohn, give an idea of their deregulation vision, starting with a dismantling of the Consumer Financial Protection Bureau. Legal proceedings are currently underway to decide whether the director of the agency can be fired immediately or the Trump administration must wait until the end of his term.
Another key piece of regulation currently under review is the so-called Volcker rule, which prohibits banks from carrying out particularly risky transactions. This includes proprietary trading, which involves banks trading with their own funds for their own profits. Under current regulations, banks are only allowed to buy and sell securities in connection with customer business. Goldman Sachs is particularly affected by the Volcker rule, but chances are that it will soon have limited or no application.
According to an interview with Mr. Cohn in the Wall Street Journal, the Trump administration will also be reviewing “living wills”. These are the massive blueprints currently required for banks to show that they can weather a financial crisis without using taxpayers’ money. Critics of these living wills, including Neel Kashkari, head of the Federal Reservie district of Minneapolis, don't think they would be effective in a financial crisis. Within the industry, however, it is widely acknowledged that crisis blueprints have contributed to the simplification of corporate structures.
Some of the tightened rules since the financial crisis will remain in place, however: "Interestingly, there was still no question of lowering the level of capital buffers or changing the way in which assets are calculated," Daniel Alpert, co-founder of the Westwood Capital investment bank, said.
Even before Mr. Cohn’s switch from Goldman Sachs to government, he had emphasized the importance of smarter – as opposed to less –regulation. Additionally, good capital and liquidity terms give U.S. banks a competitive advantage over their European competitors. And increasing that advantage seems to be Mr. Trump’s main objective. As Mr. Cohn described the goal of the new administration’s deregulation plans: “It has to do with being a player in a global market where we should, could and will have a dominant position as long as we don’t regulate ourselves out of that.”
Astrid Dörner is part of Handelsblatt’s team of correspondents covering finance and U.S. corporations in New York. Moritz Koch is Handelsblatt’s Washington correspondent. Yasmin Osman is an editor with Handelsblatt’s banking team in Frankfurt. Frank Wiebe is a New York correspondent for Handelsblatt, covering finance policy. To contact the authors: [email protected], [email protected], [email protected], [email protected]