Financial regulation in the US: as the world turns and the pendulum swings

September 2018 | PROFESSIONAL INSIGHT | BANKING & FINANCE

Financier Worldwide Magazine

September 2018 Issue

“Money makes the world go round” said the stars of the 1966 musical Cabaret. But who makes the money go round? Bankers and other financial professionals. Yet financial professionals are not always appreciated. A May 2017 CATO survey of 2000 Americans found that 48 percent have “hardly any confidence” in financial institutions. At the same time, another 48 percent have “hardly any confidence” in financial regulations. Similarly-split views were featured in Pew and Gallup surveys conducted in late 2017 and in a survey of bank reputations released in June 2018 by the American Banker magazine and the Reputation Institute.

The two opposing views shown in the CATO survey and others are perfectly balanced around a neutral fulcrum of the rare folks who have no opinion on the matter. To put it bluntly, Americans either hate banks and love regulations, or hate regulations and love banks. No wonder we have a giant ‘pendulum’ that swings back and forth between regulation and deregulation of financial institutions in America.

This pendulum swing generally tracks with political power. Regulation tends to be stronger when Washington is under Democratic control, while deregulation tends to be stronger when Washington is under Republican control.

Let us take a quick look at the broad movements over time.

After the Great Crash of 1929, regulation was the order of the day. The Banking Act of 1933, also called the Glass-Steagall Act, included provisions separating commercial and investment banking. That same year, the Securities Act of 1933 established the modern infrastructure for regulating securities issues, followed the next year by the Securities Exchange Act of 1934, for trading, with its famous 10(b)5 restriction on insider trading, and then several years later by the Investment Company Act of 1940, regulating mutual funds.

In 1996, the pendulum swung toward deregulation. The Economic Growth and Regulatory Paperwork Reduction Act (EGRPRA) created incentives for deregulation at the federal agency level. In financial services, the Financial Services Modernization Act of 1999, also known as the Gramm-Leach-Bliley Act, repealed the Glass-Steagall provisions and allowed commercial banks to engage in some investment banking activities.

Then it was back to regulation. The Sarbanes-Oxley Act of 2002 included a Section 404 increasing focus on the internal control environment for public companies, including financial institutions. A mere eight years later, the Dodd-Frank Act of 2010 entered the scene, with myriad new financial rules, including its sections 747 outlawing ‘disruptive practices’ in trading and 753 prohibiting ‘manipulation and false information’, as well as a provision that led to the so-called Volcker Rule restoring aspects of Glass-Steagall. The Volcker Rule, which came into force on 1 April 2011, subject to extensions, generally prohibits banking entities from engaging in proprietary trading in securities, derivatives or certain other financial instruments and from investing in, sponsoring or having certain relationships with a hedge fund or private equity fund. Dodd-Frank also created a whole new set of requirements for institutions that the Financial Stability Oversight Council deems to be Systemically Important Financial Institutions (SIFI). And it is difficult to shake the designation: Section 117 is nicknamed the ‘Hotel California’ provision – referencing the 1977 Eagles song: “You can check out any time you like, but you can never leave!”

More recently, we have seen a shift to deregulation once again. President Trump has vowed to “dismantle” Dodd-Frank broadly, including the Volcker rule. The President’s Executive orders 13771, 13772 and 13777 are helping.

Executive Order 13771 (1/30/2017) called for the repeal of two regulations for every new one. This has led to a near-freeze on new regulations. According to a December 2017 White House report titled ‘Regulatory Reform: Two-for-One Status Report and Regulatory Cost Caps’, leading departments and agencies under president Trump spent their first year doing away with 67 old regulations while instituting only three new ones, a 22:1 ratio.

Executive Order 13772 (2/3/2017) ‘Core Principles for Regulating the United States Financial System’ was issued by all the main bank regulators (The Federal Reserve Board, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation and the National Credit Union Administration). It reiterated the importance of EO 13771 and its predecessor, the EGRPRA of 1996. A deregulatory memo dated 3 February 2017 on a ‘fiduciary duty’ rule pushes back against that regulation, which would force even small investment advisers to register with the Securities and Exchange Commission (SEC). Then, on 21 June 2018, the US 5th Circuit Court of Appeals, based in New Orleans, gave the coup de grace when it vacated the rule.

And if that were not enough, Executive Order 13777 (2/24/2017) required agencies to implement 13771 and similar orders, requiring each agency to appoint a “regulatory reform officer”.

This last executive order has had a strong impact. The Department of Treasury has already issued three major reports on regulatory streamlining, including one for banks and one for asset management and insurance industries. And on 5 June 2018, five federal financial regulators released a proposed rule to “simplify and tailor” ease compliance requirements relating to the Volcker Rule. The proposal was jointly developed by the Federal Reserve Board (FRB), the Commodity Futures Trading Commission, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the SEC.

The FRB has also joined the deregulatory movement. Randal Quarles, the FRB’s vice chairman for supervision, gave statements in April 2018 to the Senate Banking Committee (chaired by Mike Crapo), and to the House Financial Services Committee (chaired by Jeb Hensarling). Quarles said the FRB has reduced the burden of stress testing and is working to simplify the Volcker Rule and clarify the Community Reinvestment Act (a law that Republicans have blamed for the mortgage market meltdown that triggered the global financial crisis a decade ago). Quarles also promised deregulatory reforms in liquidity (calibrating by size), living wills (less frequent and simpler), and supervision and examinations (to be less burdensome).

Meanwhile, in Congress, there has been much activity on the financial deregulatory front. As for the Senate, Chairman Crapo’s bill S 2155 Economic Growth, Regulatory Relief, and Consumer Protection Act, became law on 24 May 2018. This new law eases rules for mortgage lending by small banks, exempts banks with less than $10bn in assets from the Volcker Rule, increases permissible debt levels for certain bank holding companies, increases asset threshold triggering enhanced prudential standards, increases the asset threshold for mandatory risk committees on boards from $10bn to $50bn, and expands the applicability to issuers of ‘Regulation A+’, making it easier to file initial public offerings (IPOs). In the House, leaders added many new provisions to an existing Senate bill, S. 488, JOBS and Investor Confidence Act of 2018, and passed it overwhelmingly, sending it back to the Senate for a final vote. Nicknamed ‘JOBS 3.0’, referencing the 2012 JOBS Act, this bill targets small companies trying to go public.

But these two landmark events are only a small part of a larger deregulatory movement in Congress.

A recent search of titles and summaries of proposed bills in the Library of Congress revealed more than 200 bills and resolutions with the word ‘bank’ in them. One quarter of these have already passed the House or the Senate.

With S. 2155 now law, and the S. 488 ‘package’ bill on its way, the momentum for brand-new banking bills has slowed, but dozens of Republican-sponsored deregulatory bills that have passed the House are still awaiting Senate action. Their titles reveal their deregulatory nature: Stress Test Improvement Act, Financial Stability Oversight Council Improvement Act, Financial Institutions Examination Fairness and Reform Act, Taking Account of Institutions with Low Operation Risk (TAILOR) Act, Community Bank Reporting Relief Act, Comprehensive Regulatory Review Act, Portfolio Lending and Mortgage Access Act, Protecting Consumers’ Access to Credit Act, Small Bank Holding Company Relief Act, Mortgage Choice Act, Financial Institution Living Will Improvement Act and Expanding Investment Opportunities Act.

Will any of these become law? Let us remember that this Congress will be ending soon, with the entire House up for re-election, along with one-third of the Senate. In November 2018, voters could usher in a new House with a regulatory bent… putting the old pendulum back to work. And that pendulum could swing back to more financial regulation, accompanied by predictable popular sentiment of the anti-banking variety – that ‘other half’ which pushes the pendulum back toward more regulation periodically. And where will that leave financial professionals?

The CATO survey has bad news and good news.

The bad news is that while barely half of Americans say they have ‘hardly any confidence’ in financial institutions, a supermajority mistrust financial professionals as people: 77 percent believe bankers “would harm consumers if they thought they could make a lot of money doing so and get away with it”, 72 percent believe Wall Street bankers are “more greedy and selfish” than other people, and 64 percent think Wall Street bankers “get paid huge amounts of money” for “essentially tricking people”.

And the good news is that customers do not apply these labels to their own financial advisers. The same CATO survey asked Americans about their providers. Scores were high: 83 percent trust their mortgage lender, 87 percent their credit card issuer and 90 percent trust their banker. This positive rating comes in part because financial professionals are doing their jobs day in and day out – making money, and the world, go round.

Alexandra R. Lajoux is chief knowledge officer emeritus of the National Association of Corporate Directors (NACD). She can be contacted on +1 (202) 255 7562 or by email: arlajoux@nacdonline.org.

Alexandra R. Lajoux

National Association of Corporate Directors (NACD)