Since US regulators loosened the Volcker rule that bans banks from engaging in proprietary trading, reactions have been starkly different.
Banking lobbyists downplay last week’s changes to regulations designed to prevent banks from using insured deposits to make risky short-term bets. They say the changes reduce fiendishly complex compliance rules that make it hard for bankers to do their main jobs of making markets and providing services to clients. As a result, they say, the rule change should boost liquidity in the debt markets, which would make them more resilient in case of a downturn.
The industry argues that higher capital requirements for trading in general — more than three times pre-2008 levels — will prevent a repeat of the financial crisis. “The largest US banks are not prop trading now, and they will not be prop trading tomorrow,” says Kevin Fromer, who heads the Financial Services Forum, which represents the biggest US banks.
Consumer groups and some regulators see the Volcker rule change quite differently. The new version cuts the pool of financial instruments covered by the rule by at least one-quarter, according to a regulator who voted against the change. It not only frees banks up to take more short-term bets but also reduces the documentation requirements, opening the door to more risky trading. Critics also point out that if banks find ways to trade on their own account, rather than for clients, it could reawaken the poisonous conflicts of interest that flourished ahead of the 2008 crisis.
“Banks didn’t spend nine and a half years and tens of millions lobbying to get these rules changed if they didn’t want to do prop trading and it wasn’t going to return them many multiples on what they spent,” says Dennis Kelleher of the advocacy group Better Markets.
The Volcker rule rewrite is part of a much larger shift under US president Donald Trump, who came into office promising to kill two regulations for every new rule he put in place. Supporters and opponents agree that he has far exceeded that ratio. Acting budget director Russell Vought boasted this summer that “we’ve hit 13 to one”, adding that the eliminated rules had saved taxpayers $33bn.
Liberal groups keep running lists of the rules and regulations Mr Trump’s administration has watered down or scrapped. This month alone, according to the Brookings Institution, there are seven entries and the Volcker rule hasn’t been included yet. They include weakening the Endangered Species Act, reducing penalties on automakers who fail to meet fuel efficiency standards and rejecting a ban on chlorpyrifos, a pesticide linked to developmental and autoimmune disorders.
In the financial sector, this change in attitude has led the US Federal Reserve to scrap one prong of its annual stress tests and ease the requirements for midsized banks to write “living wills” that lay out how they could be wound down in a crisis. A new rule requiring brokers to act in the “best interest” of their clients is seen as much less strict than a scrapped Barack Obama administration proposal that would have imposed a “fiduciary duty” on advisers.
Industry insiders also say that the tenor of their interaction with government supervisors has changed. These days, examiners are much less inclined to put banks in a “penalty box” that prevents them from growing over anti-money laundering issues and other “matters requiring attention” (supervisor speak for “you need to fix this”).
In some senses, this is par for the course. The US historically pingpongs between fits of regulation and spasms of deregulation, often depending on who is in power. The American system is also blessed — or cursed, depending on your perspective — with activist state officials who club together to try to counter overarching trends. Republican attorneys-general tried to block Obamacare; now Democratic attorneys-general are challenging Mr Trump’s environmental policies, launching antitrust probes of big technology companies and trying to stop mergers that federal regulators have approved.
The combination of US loosening and state tightening echoes the mid-2000s, when George W Bush’s administration was dismantling environmental rules and declining to rein in hedge and mutual funds, while state officials led by Eliot Spitzer were using their enforcement powers to try to counteract him. (Yes, the biggest bank deregulation law passed under Bill Clinton, but Mr Bush continued the trend.) That era, as you may recall, ended with the collapse of Lehman Brothers in 2008.
Back in 2019, the US is still subject to much stricter global capital and liquidity requirements, put in place after the crisis, as well as much of the Dodd-Frank financial reform act. And there is no evidence that America is suffering for it. The industry reported record 2018 profits and the US economy is still outpacing most of the developed world.
But fears of a recession are rising and there are concerns about the swollen leveraged loan market. It seems like a good time to reinforce our financial defences rather than weakening them. Remind me, why exactly are we deregulating the banks right now?
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