One of President Donald Trump’s stated goals for his first 100 days is to roll back much of the legislation passed by the Obama administration. And not surprisingly, one of the first targets is the Dodd-Frank financial reform legislation that was passed in the wake of the 2008 financial crisis and Great Recession. The objective of Dodd-Frank was to make the financial system safer, in part by putting something of a wall between risky trading and plain vanilla commercial bank lending (via the Volcker Rule). Separately, the administration also passed a rule requiring financial advisors to actually make investments that are in the best interests of their clients, rather than simply selling products with the highest fees (the fiduciary rule).
The Trump administration is now trying to turn back both provisions. What effect will this have on the financial system itself?
Let’s start with Dodd Frank and the Volcker Rule. Many critics (and there are plenty, both on the Democratic and Republican sides of the aisle) will correctly point out that merely separating trading and lending wouldn’t have prevented things like the collapse of AIG, not to mention past financial crises like the savings and loans crisis of the 1980s. It’s also true that many of the largest US financial institutions have actually started to do less trading not because of the Volcker Rule, but because new Federal Reserve rules require them to hold more cash and cash equivalents, which makes it tougher for them to take the sort of risks required to do risky trading.
Yet while the TBTF banks have actually done plenty of deleveraging of their own accord, there’s a greater principal at stake here — the mission and purpose of the financial system in general. As I write in my book, Makers and Takers: The Rise of Finance and the Fall of American Business, the rise of things like proprietary trading is part of a larger rise of finance relative to business from the 1980s onwards. Finance today represents seven percent of the US economy, yet creates only four percent of jobs, and takes a whopping 25% of corporate profits. Capital requirements, while higher than they were prior to 2008, are still relatively low — banks regularly conduct daily business with over 90% borrowed money, something which creates fundamental instability in the system.
Turning back the Volcker Rule would send a message to the industry that nothing fundamentally needs to change in the financial system — that it can continue serving mainly itself, rather than business as a whole. Today, only about 15% of the financial flows out of the big US financial institutions go into business investment, as opposed to the 1970s, when the majority of financial flows would have gone into business investment — the rest goes into the buying and selling of existing assets. That shift has coincided with a decline in start-ups per capita, lower R&D spending on the part of businesses, and a general decrease in the sort of entrepreneurial zeal that creates real economic growth, rather than the false, financialized kind.
As for the fiduciary rule, it’s hard to think of any legitimate reason why financial advisors shouldn’t be legally required to look after the best interests of their clients. As I write in my book, the asset management industry is not only the fastest growing but also one of the most problematic parts of the financial sector — only a handful of actively managed mutual funds outperform the market, and yet millions of Americans are invested in poorly performing, high fee funds that eat up anywhere from 30% to 60% of their retirement savings by some estimates.
In recent years, the discussion around fiduciary duty has led to greater awareness of this problem on the part of investors, and that’s why you are seeing more and more people putting their money — rightly so — into market tracking, no or low fee index funds, rather than paying money managers huge fees for under-performing the market. Turning back the legal requirement for managers to tell investors the truth would be a boon for Wall Street, and a terrible disservice to Main Street. It would also say quite a lot about where the Trump Administration’s priorities — and loyalties — lie.