CFA Society Singapore
Donald Trump’s shock victory has led to irate protest marches. Wall Street bankers were not among those holding placards.
The president-elect’s promise to repeal the onerous Dodd-Frank Act is music to the ears of beleaguered bankers. The Dodd-Frank Act was passed in the wake of the global financial crisis (GFC) of 2008.
It was the most radical piece of financial regulation since the 1930s. President Barack Obama hoped the legislation would “lift our economy”. The Act, which runs into thousands of pages, vowed to “end too big to fail” and “promote financial stability”.
Dodd-Frank was driven by the canard that the financial crisis was a result of deregulation. Actually, regulation of financial services expanded every year from 1999 to 2008. GFC was not due to deregulation but poor regulation.
The US government’s affordable housing policy led to a weakening of underwriting standards. Lenders took on homes that they could not afford. The Federal Reserve fuelled the bubble by suppressing interest rates. Inflated housing prices caused an immense strain on the world’s financial system.
Dodd-Frank has been a millstone around the neck of the financial sector. It has harmed not just Wall Street, but Main Street as well. The most draconian part of the Act was the “Volcker rule”, which bars banks from proprietary trading in the stock and bond markets.
By restricting banks from proprietary trading, the Act has damaged the corporate bond market. Liquidity in the world’s corporate bond markets has fallen by a fifth in the last five years. The evaporation of liquidity worsens risk. Markets are now more vulnerable than during the height of GFC.
Another outrageous feature of Dodd-Frank was the enthronement of bureaucrats. It created the Consumer Financial Protection Bureau. The director of this agency can outlaw any consumer credit product, and CFPB can override Congress and the courts. This has had a severe impact on consumer lending in the US, where recovery from GFC has been tepid.
The Act has made the Fed effectively board members of every large financial institution. The Fed has “heightened prudential supervision” over large banks. This provision can extend to asset management, insurance companies and even conglomerates such as GE.
The upshot of Dodd-Frank is the heavy cost of compliance. Banks have had to hire more personnel to grapple with the red tape and they are constrained from lending. This has throttled US recovery and, by extension, the world economy.
It has also made the big banks bigger and driven small banks into oblivion. The number of banks with an asset base of less than US$50 billion has fallen sharply by a fourth, removing a valuable source of credit.
In the wake of Trump’s win, US bank stocks have surged. The Financial Select Sector SPDR exchange-traded fund has rallied more than 10% since Aug 9. The rally has been supported by the surge in bond yields. JP Morgan Chase & Co, one of the largest components of the ETF, has hit alltime highs. Goldman Sachs Group and Bank of America are up 14%.
This may be only the beginning of a sustained rally. Several US banks stocks are trading at a 40% discount to their tangible book value. This is almost two standard deviations from the mean over the last quarter century.
On price-to-earnings multiples, they are dirt cheap. The valuations of the major US banks are at just 12 times forward earnings, compared with 18 times for the Standard & Poor’s 500 index. This is well below the peak valuation of 33 times that was achieved in May 2009 before the jackboot of regulation was imposed.
The repeal of Dodd-Frank is one of several triggers for unlocking value. Trump’s win may also lead to inflation. He plans to widen the fiscal deficit with a massive infrastructure programme. The yield on 10-year Treasury has risen 25% since his win and the yield spread has widened. This has improved the earnings prospects of banks.
The rosy outlook for banks should not obscure the risks. Dismantling the regulations will take several months of tortured negotiations. Trump will have to contend with the interest groups that are surviving like leaches on the largesse of Dodd-Frank.
As his unexpected win shows, Trump can defy the odds. US banks may be about to rise from a sevenyear rout on the shoulders of a reality- TV star.
Nirgunan Tiruchelvam is director of Religare Capital Markets.
This article appeared in the Corporate of Issue 755 (Nov 21) of The Edge Singapore.