Debates about financial regulation tend to focus on quantity, not quality. But “more versus less” isn’t so much the issue; the details are. And when it comes to financial reform in the United States, President Donald Trump is unlikely to get the details right.
Earlier this month, Mr. Trump issued an executive order directing a comprehensive review of the Dodd-Frank financial reform legislation of 2010. The administration’s goal is to scale back significantly the regulatory system put in place in response to the 2008 financial crisis. This is a risky move.
Dodd-Frank’s key features – such as higher capital requirements for banks, the establishment of the Consumer Financial Protection Bureau, the designation of Systemically Important Financial Institutions, tough stress tests on banks, and enhanced transparency for derivatives – have strengthened the financial system considerably. Undermining or rescinding them would substantially increase the risk of an eventual recurrence of the 2007-2008 financial crisis.
Canceling the fiduciary rule would have no purpose other than to maximize financial institutions’ profits, at the expense of the average American family.
This is not to say that current legislation could not be improved. The most straightforward way to do that would be to restore some of the worthwhile features of the original plan that have been weakened or negated over the last seven years. Dodd-Frank might, in theory, also benefit from a more efficient tradeoff between the compliance costs that banks and other financial institutions confront and the danger of systemic instability (in areas like the “Volcker Rule” restricting proprietary trading by banks).
But achieving this would be a difficult and delicate task. Contrary to what some in the financial industry seem to believe, there is no evidence that Mr. Trump will manage it properly. On the contrary, even before the review of Dodd-Frank gets going, Mr. Trump has already gotten financial regulation badly wrong.
As Mr. Trump ordered the review of Dodd-Frank, he also suspended implementation, pending review, of the so-called fiduciary rule that was adopted, after extensive preparation, by former president Barack Obama’s administration. The rule, which was supposed to take effect in April, is intended to ensure that professional financial advisers and brokers act in the best interests of their clients when collecting fees to advise them on assets invested through retirement plans.
The need for such a rule is clear. Many investment advisers and brokers are motivated by conflicts of interest to recommend a stock, bond, or fund that is not quite as good as another. For example, the adviser may receive an undisclosed commission or de facto kickback for recommending a particular product. It may be the advising firm’s own offering. Because most investors assume that their advisers are obliged to act in their best interests, they don’t second-guess the recommendations. The end result is underperformance of the saver’s retirement account.
Canceling the fiduciary rule would have no purpose other than to maximize financial institutions’ profits, at the expense of the average American family. The rule’s opponents make the argument that the requirement amounts to government overreach, because it deprives families of choices. This is disingenuous, because it disregards the reason why savers seek the services of financial advisers in the first place: to help them figure out what investments best serve their interests.
A saver could always choose not to hire a financial adviser. Those who believe their judgment to be superior to that of the average investor can choose which individual assets or actively managed funds to buy and sell. Such investors distill information on their own and have no need for a retirement savings adviser to help them sift through the huge variety of financial assets, products, and funds available, particularly in a country like the United States.
But there are downsides to this approach. Most investors who pursue it buy and sell too often, burn through a lot of money in cumulative transaction costs and are unrealistically optimistic about their ability to pick winners, or time the market.
In this sense, the financial industry is no different from the used-car business.
An alternative, recommended by most economists, would be for savers simply to park their money in broadly diversified low cost funds, such as the index funds offered by Vanguard. Here, too, there is no need for a professional adviser. Recommended allocations of individuals’ total financial wealth are something like 60 percent equities, 30 percent bonds, and 10 percent cash, depending mainly on the saver’s degree of risk aversion and need for liquid assets.
Yet many small investors just can’t bring themselves to believe that index funds are the best they can do. Recognizing that they lack the time, skills, or interest necessary to invest their savings independently, they seek the services of an investment adviser. They want to discuss their portfolios with an expert, with someone they can trust to give them good advice. But if that expert can’t be relied upon to put savers’ interests first, why are they collecting fees?
Of course, not all financial advisers act contrary to their clients’ interests. Some apply a fiduciary standard in practice, to earn their clients’ trust, even though the law does not yet require them to do so. Truly ethical advisers tend to support Mr. Obama’s fiduciary rule, because the removal of unscrupulous competitors is good for their business.
In this sense, the financial industry is no different from the used-car business. The dealers who would oppose a law preventing them from turning back the odometer are probably the ones engaging in that practice. Honest dealers would favor it as a way to level the playing field. They do not claim that such laws deprive consumers of the “choice” to buy a used car under fraudulent terms.
It is in ordinary Americans’ best interest for the fiduciary rule to go into effect in April, as planned. They would be best served if the Trump administration kept its hands off Mr. Obama’s other financial reforms, too.
Copyright: Project Syndicate, 2017.www.project-syndicate.org
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