Taking Measure of Deregulation

As a reminder, our political analysis is nonpartisan and focuses exclusively on political developments’ potential market impact (or lack thereof). We favor no party, politician or ideology and believe political biases lead to investing errors.

Since the election, media have seemingly viewed market movements through a Trump lens, frequently overstating the administration’s influence on stocks in the process. One example is financial regulation. Trump, we are told, is “leading a deregulatory charge,” which the White House claims amounts to striking nearly 1,000 separate rules. This, proponents argue, is driving stocks higher—bank stocks in particular. In our view, however, the hype surrounding the Trump administration’s financial deregulation efforts doesn’t match reality. The administration’s tone is pro-business, but that is about the only material difference from past administrations.

Yes, they have done stuff, but it mostly amounts to small tweaks. The Financial Stability Oversight Council (FSOC) released insurer AIG from its “too big to fail” designation but didn’t declare insurance giants universally exempt. Congress blocked the Consumer Financial Protection Bureau’s (CFPB) attempt to ban arbitration clauses in consumer finance contracts but didn’t kill the agency. The Comptroller of the Currency started the process of (perhaps) revamping Dodd-Frank’s Volcker rule, which bans most of banks’ proprietary trading, but this will be a long effort. There is also some legislation in the works, including a House bill to roll back parts of Dodd-Frank and a bipartisan push to reduce the number of banks labeled “systemically important” and subject to tougher regulation.

Executive agencies might have more business-friendly leaders who take softer interpretations of existing laws, but they aren’t exactly tearing up the rulebook. The Department of Labor recently delayed enforcement of its fiduciary rule for brokers working with retirement accounts—potentially a precursor to full repeal, but we won’t know for a year. The SEC and Commodity Futures Trading Commission have levied fewer fines on financial firms this year, and less aggressive executive agencies could reduce businesses’ compliance burdens, but this is marginal.

While some of the changes or proposals are noteworthy, none amount to a sweeping overhaul on par with interstate banking restrictions’ relaxation in the 1980s and early 1990s, or Gramm-Leach-Bliley ending Glass-Steagall in 1999. Dodd-Frank is intact with no plans for repeal. Despite Congress’s potential tweaking, core planks remain—like bank stress tests and tougher capital requirements. In some areas, Dodd-Frank regulatory powers seem poised to expand. Trump’s Treasury recently proposed empowering the FSOC to subject financial firms to additional supervision if they are engaged in activities the agency deems a threat to financial stability. This would jack up compliance burdens based solely on the opinion of unelected bureaucrats. For example, if Ben Bernanke had his way back in 2008, the Fed could have used the threat of extra scrutiny to prevent money market funds from investing in longer-term assets like auto loan debt. Giving regulators with little Congressional oversight that much power was a move even the supposedly overreaching Obama Treasury thought was too far. This change may not happen, but it shows executive agencies aren’t lining up to surrender their turf. 

Remember those 1,000 regulations the administration says it struck? 860 were merely proposed rules—not yet on the books. Similar to the aforementioned CFPB arbitration ban Congress struck down, which wasn’t in force at the time. The Obama White House had already shelved many of them. An analysis by Bloomberg and the Brookings Institution found all of 27 rules that were in force have been repealed to date. To be sure, the current administration has issued fewer new rules than its predecessors—a change with some possible downstream effects. But this isn’t the same as a deregulation frenzy.

Media also made much of self-professed CFPB opponent Mick Mulvaney’s appointment as the agency’s acting head, but he isn’t leading a radical overhaul thus far. This isn’t totally surprising. The CFPB is an agency with largely unchecked power. You hate it when you are in opposition but love it when you are in power. Note: For all the GOP’s hatred of the CFPB while Obama was in office, they aren’t advancing the repeal bill.

But they are trying to toughen other rules. Another bill currently winding through Congress would force the Treasury Secretary and two-thirds of the Federal Open Market Committee (the Fed’s decision-making body) to sign off on all emergency loans to banks. Current rules require only the vote of five Fed Governors. It would also require Congress to approve the loans retroactively within 30 days. If Congress declined, the recipient would have to repay the money immediately—not a great way to battle a financial crisis. All this would politicize the Fed and constrain its ability to act as a lender of last resort—its original purpose. That said, Congress proposes far more bills than it passes, so presuming this is a done deal would be hasty to say the least.

For all the talk about deregulation driving bank stocks, US Financials’ returns this year are super choppy.

Exhibit 1: S&P 500 Financials Being Super Choppy

Source: FactSet, as of 12/7/2017. S&P 500 and S&P 500 Financials total return indexes, 12/30/2016 – 12/6/2017.

It also seems a stretch to argue actual deregulation would be some massive positive. Several parts of Dodd-Frank were a solution in search of a problem, but the bill didn’t exactly sink US banks. Initially, higher capital requirements were a headwind. Banks deleveraged, shedding assets deemed “risky” and lending less in order to build capital buffers. But that was temporary. As banks reached full Dodd-Frank compliance, they began lending more. The recent slowdown stems from the flatter yield curve, not regulatory headaches.

Exhibit 2: Bank Lending Up

Source: Federal Reserve Bank of St. Louis, as of 12/8/2017. Year-over-year change in loans and leases in bank credit, all commercial banks (weekly), 3/11/2009 – 11/29/2017.

Regulatory stuff gets ink, but US Financials have other drivers. Regardless of what policies lawmakers chew over, the flatter (but not too flat!) yield curve probably has a larger influence over banks’ profits and relative returns. The gap (or “spread”) between US long and short rates has narrowed this year. Since banks make money by borrowing short and lending long, this likely cuts into their profits. We aren’t saying regulatory stuff doesn’t matter! But for good or ill, it just doesn’t seem to be a swing factor these days.