Dodd-Frank: the worst cut is the deepest

Dodd-Frank was seen as an essential calming measure designed to ensure that the US financial system would never again come close to total meltdown. The Trump administration wants it rolled-back. We take a look at the reasons for this and where this leaves the future direction of American banking.

dodd-frank act

As an avid golfer with thousands of rounds, played on some of the world’s toughest courses, under his belt, Donald Trump is used to aggressively letting fly at whatever’s lying ahead of him. As the 45th President of the United States, it’s therefore no surprise to see him using a similar modus operandi in his quest to ‘make America great again’. The new era was barely 2 weeks old when Trump limbered up and swung a heavy verbal club, unleashing a powerful drive aimed right at the heart of US financial regulation, namely the Dodd-Frank Wall Street Reform and Consumer Protection Act. Shooting from the lip, as has become his trademark, at a meeting of the Strategy & Policy Forum held on February 3rd 2017 Trump remarked that “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 that can’t borrow money, 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”. Fore!

As an anti-establishment outsider, Donald Trump is the antithesis of a career politician. Consequently, making comparisons with his predecessors and other historical statesmen is a hard task. Mentioning Trump in the same paragraph as Benjamin Franklin (one of the United States’ Founding Fathers) is a stretch for any writer. But there is at least one similarity between the two. Franklin famously opined that “well done is better than well said”. While Trump loves to let words spill forth in an entertainingly unconventional stream of consciousness, his verbosity is matched with actions in the form of Executive Orders. He loves these too. Hours after he’d delivered the aforementioned comments, the President signed a new EO on Core Principles for Regulating the United States Financial System. In 408 words, President Trump has set out his intention to substantially reduce the reach of Dodd-Frank, all 849 pages of it. In Trump’s America, lifting the burden of regulation will act as a shot in the arm for Uncle Sam’s economic rehabilitation. At least, that’s the theory. Personally, I’m not convinced it’s as simple as that.

Let’s briefly remind ourselves of what Dodd-Frank exists for. Conceived in the post-crises period, this bipartisan piece of legislation decrees that banks operate with increased capitalisation so as to prevent a repeat of the industry implosion which occurred between 2007 and 2008. The act is also responsible for improving industry-wide compliance and reporting standards, which were found wanting, as well as introducing tighter controls for mortgage lending, creating the Financial Stability Oversight Council and the Consumer Financial Protection Bureau, and bringing an end to risk-laden casino banking which was being practiced irresponsibly by firms deemed too-big-to-fail. At a time of extreme market volatility and sectoral risk, Dodd-Frank was seen as an essential calming measure, designed to ensure that the US financial system – and that of the wider world – would never again come close to total meltdown. And yet less than 7 years since it came into force, and after all the work performed within the industry – at huge expense – to meet the requirements, the Trump administration wants it rolled-back.

Is this really just because the President’s friends, running their nice businesses, can’t get access to funding? Is Dodd-Frank really no longer fit for purpose? Is it really – to quote Sean Spicer, the combative White House press spokesman – “a disastrous policy that’s hindering our markets, reducing the availability of credit, and crippling our economy’s ability to grow and create jobs”? Do certain inhabitants of Capitol Hill really have short memories, to the point that they’re willing to recreate trading conditions where banks are over-leveraged and speculative lending is rampant? Has Dodd-Frank really, to quote Spicer again, “done the opposite of what it intended to do”? Would the US financial sector really have recovered quicker and better without Dodd-Frank?

The answer to each question depends on the lens through which Dodd-Frank is viewed and by whom. Republican congressional members, from across the spectrum of the party and not just those within the Trump faction, have consistently called the act’s effectiveness into question. Murmurings of discontent in relation to lending, growth and innovation were being heard a long time before the inauguration of January 20th. In President Trump, dissenters now have the ultimate human amplifier through which to make their grievances louder. And for the remainder of his first term in office, he’ll likely stay turned all the way up to 11 (as that’s clearly his default setting).

From a dispassionate perspective, Republican concerns have some legitimacy. Lending could be easier, particularly to smaller ‘mom and pop’ enterprises who form an important part of the economy and yet often find themselves underserved. But griping about Dodd-Frank constraining innovation is unjustified. Rather, innovation – under the fintech banner – is being impeded by the complexities of the financial regulatory structure, with responsibilities fragmented among multiple agencies that have overlapping areas of jurisdiction. As a result of this, financial institutions may fall under the authority of multiple overseers, and while the Dodd-Frank Act made a number of reforms, the regulatory structure of the US has generally remained unchanged. Ergo, the Act can’t be held responsible for hindering progress. To this end, I believe the focus of the administration’s efforts would potentially be better spent reducing supervisory complexity by making changes to the overall regulatory structure, rather than performing a roll-back – or full repeal – of Dodd-Frank.

Those sitting on the Democratic side of the House have also voiced concerns over the disproportionality of the regulatory burden being placed on smaller institutions (measured by asset value) and community banks. Again, this is legitimate, and interestingly isn’t just a complaint from one set of voices. In a National Economic Council Listening Session, convened on March 9th, Trump spoke about how “one-size-fits-all banking regulations have badly hurt America’s community banks”.

As an interested outside observer – I’m neither American nor a resident of the United States – Dodd-Frank isn’t perfect. But it was a necessary, née essential, piece of legislation, which confronted the industry’s shortcomings head-on and put critical controls in place which have so far prevented a repeat of the problems which caused the worst financial crisis in living memory. Could – and should – it be adjusted so that it remains fit for purpose? Yes. Could – and should – it be revisited on a similarly bipartisan basis to the one which conceived it? Yes. Will it? The jury’s out on this one (but it shouldn’t be dismissed out of hand as an option).

Where does this leave the future direction of American banking? Right now, it’s in a state of limbo. Steven Mnuchin, the man appointed by President Trump to serve as the Secretary of the Treasury, is conducting a full review of Dodd-Frank as part of the EO signed on February 3rd. Mnuchin has to report findings within 120 days of this date, so clarity over likely next steps will emerge in the coming weeks. After a flurry of activity and commentary from the White House during the entire month of February, March has been appreciably quieter. This is understandable, given we’re still in the review period. But we can expect things to get louder and louder during April and May.

Roll-back, or repeal, will inevitably bring challenges with it. President Trump’s remarks indicate a desire and determination to make big changes. But potentially the worst cut is the deepest. While it may please certain politicians and business leaders, it’s not guaranteed to be welcomed with open arms by the banking industry en masse. The sheer amount of activity performed to comply with Dodd-Frank dictates that the prospect of a large cut isn’t especially appealing, as effectively previous efforts will be rendered pointless. Blood spilt, sweat exerted, tears shed, all for nothing. And given the rules which govern US elections, who’s to say that there won’t be an entirely new leader after voters go to the polls on November 3rd 2020 (the inauguration is scheduled for January 21st 2021). If the incoming president decides on a different course of action for the financial industry, it will be a case of all-change…again. Modest adjustments to the existing Dodd-Frank Act would seem to be the most pragmatic course of action. But modesty and Donald Trump simply don’t go together. History, be it recent or ancient, is always a useful guide as to the future. Trump’s election victory stunned the world, and showed us that we should expect the unexpected. Frankly, nothing would surprise me when it comes to the next steps in US – and global – banking. Let’s wait for the findings of Mnuchin’s review, and be fully prepared to drop our popcorn at what’s going to happen as a result.