A new dawn on Wall Street?
The election of Donald Trump is fuelling both hope and fear of an era of growth in global finance
Seven days after the U.S. presidential election, Thomas Montag, the second-in-command at Bank of America Corp., welcomed a group of investors to a conference in New York with the air of someone slightly stunned by his good fortune.
On the day after the vote, Bank of America's trading desk had its biggest day by volume to date on the New York Stock Exchange. By the following Monday, the bank's share price had soared to its highest point in eight years, up about 18 per cent since the election.
Mr. Montag was cheered by the prospect of a Washington unfettered by gridlock and by a president eager to rev up the economy using spending. "There is this sense of optimism," he said, that the new administration will work "to supply the foundation for growth that we, as a bank, can optimize."
Donald Trump's stunning upset at the polls is turning into a surprise windfall for Wall Street. While the president-elect hasn't revealed his cabinet yet or described his plans for the financial sector in any detail, there is a sense that a new era for banks is about to begin: a period of fewer regulations, stronger economic growth, less severe penalties for missteps and higher interest rates to boost profits.
Mr. Trump's election is a "game-changer," Gerard Cassidy, an analyst at RBC Dominion Securities Inc., wrote on Thursday. It represents "the biggest paradigm shift since Ronald Reagan's election in 1980." Mr. Cassidy said the new Trump administration was an aligning of the "sun, moon, and stars" for the financial industry.
That alignment is all the more dramatic for its unexpected nature. Bankers had prepared for little change to the status quo, anticipating a victory by Democratic nominee Hillary Clinton, perhaps paired with the constraining influence of a Republican-controlled Congress. Some of them worried that Democratic Senator Elizabeth Warren, a Wall Street foe, would have more sway in a Clinton administration.
Instead, Republicans control the levers of power and major shifts are on the horizon. During the campaign, Mr. Trump called the financial-reform legislation passed in the wake of the 2008 crisis a "very negative force" and said he would dismantle it. Known as the Dodd-Frank Act, the law made the financial system safer and more stable but imposed significant regulatory burdens on banks.
Not only will there likely be an opportunity to alter Dodd-Frank, but banks are also looking ahead to a change in personnel at the top of the agencies that supervise them. Their hope is that Trump administration appointees will adopt a less confrontational and punitive approach to financial institutions.
If those legislative and personnel approaches materialize, it would mark a turning point for banks. Ever since the financial crisis, the transformation of Wall Street has proceeded in one direction: more regulation and larger penalties that have combined to make banks less profitable and a little more boring. Now, the dynamic could be reversed.
Depending on how sweeping the changes are, it's enough to make some people nervous. Not even a decade has passed since the U.S. financial system nearly collapsed. If Mr. Trump's administration loosens the constraints on banks, it must also make sure it isn't seeding the next crisis.
On Thursday, Janet Yellen, chair of the U.S. Federal Reserve Board, defended the improvements made under Dodd-Frank as critical to the safety of the system. "I wouldn't want to see the clock turned back," she said. "I do think they're important in diminishing the odds of another financial crisis."
'A handful of large corporations'
During the presidential campaign, Mr. Trump was known to bash the financial industry when it suited him. Back in January, he stated that he "wouldn't let Wall Street get away with murder." His final commercial, which aired earlier this month, featured Mr. Trump describing a "corrupt political establishment" that had stripped the country of its wealth and put it "into the pockets of a handful of large corporations." As those words were spoken, a photo of Lloyd Blankfein, the chief executive officer of Goldman Sachs Group Inc., appeared on the screen.
Yet in other respects, Mr. Trump is close to the industry. He has stacked his economic advisory team with billionaires, hedge fund managers and former Wall Street bankers. One of his rumoured picks for Treasury secretary is long time Goldman banker turned hedge fund manager Steve Mnuchin. A potential candidate for commerce secretary is billionaire investor and corporate restructurer Wilbur Ross.
Other names swirling around for Treasury secretary are Jamie Dimon, the CEO of JPMorgan Chase & Co. and Jeb Hensarling, the Republican chairman of the financial services committee in the U.S. House of Representatives. Mr. Trump's point man on Wall Street regulation is Paul Atkins, a former commissioner with the U.S. Securities and Exchange Commission. Mr. Atkins is an expert in securities law but favours a light touch on regulation.
If Mr. Dimon were to become Treasury secretary, there would be elation in the financial industry and probably in the markets as well. Picking Mr. Dimon would also "send a certain signal that ideology or loyalty" is not the crucial determinant for cabinet positions in the Trump administration, said H. Rodgin Cohen, senior chairman at Sullivan & Cromwell in New York, who is considered the dean of Wall Street lawyers.
'A back-bending effect'
One early target for Mr. Trump's administration will be overhauling Dodd-Frank, a sprawling 2,200-page statute that provides the framework for the post-crisis financial system. Implementing the most sweeping banking reforms since the Great Depression, the law aimed to protect the system from future shocks and prevent government bailouts.
Regulators forced banks to double the amount of capital they held in reserves, cut leverage in half, exit certain activities such as proprietary trading and adapt to a regime of stress tests and living wills, said Brad Hintz, a former executive at Lehman Brothers and Morgan Stanley who now teaches at New York University.
That process succeeded in making the banks far more stable. But the changes also narrowed the business strategies available to banks and decreased their trading margins, said Mr. Hintz, rendering them less profitable. Major investment banks have not been able to consistently earn a return on equity greater than their cost of capital, he added.
Among banks, there isn't much appetite for a wholesale dismantling of the law. Banks "don't love Dodd-Frank, but after five years of putting it in place, they feel sort of okay with it," said Douglas Landy, a partner at Milbank Tweed Hadley & McCloy in New York, whose clients include major financial institutions.
Last week, Mr. Blankfein, the CEO of Goldman Sachs, told a conference that he "wouldn't want regulation to be repealed in total." But he added that there are certain things "that have a back-bending effect and repress activity."
It is not known what changes Mr. Trump might target first. On his transition team website, Dodd-Frank is described as a "complex piece of legislation that has unleashed hundreds of new rules and several new bureaucratic agencies." It proposes to "dismantle the Dodd-Frank Act and replace it with new policies to encourage economic growth and job creation."
Yet, it would be difficult or impossible to demolish the entire law, as Mr. Trump has suggested. Sixty votes in the Senate are needed to enact or repeal legislation and Republicans are eight votes shy of that supermajority threshold.
Nevertheless, lawmakers could dismember or soften parts of the bill. "There would be phenomenal relief if certain parts of the act would be revisited," said Victoria Loutsiv, a partner with Deloitte who has helped Canadian banks comply with Dodd-Frank.
One target could be the Consumer Financial Protection Bureau, a new agency created as part of the Dodd-Frank legislation. Republicans are keen to either eliminate the bureau or change its one-director structure to a board. They also want to place its funding under direct congressional control, rather than under the Federal Reserve Board. Consumer advocates say that would cripple the bureau by impeding rule making and putting its resources at the whim of lawmakers.
Another contentious item that banks would like to jettison is the Volcker Rule, which bans banks from speculative trading and restricts their investments in hedge funds and private equity. To comply with that element of the statute, Royal Bank of Canada had to get rid of part of its proprietary trading arm.
Mr. Hensarling, the Republican member of Congress who heads the House financial services committee – and possible candidate for Treasury secretary – has proposed a replacement for Dodd-Frank dubbed the "Choice Act." The bill would eliminate the Volcker Rule and end a special regulatory authority to wind up major financial institutions on the brink of failure.
The bill's key provision is to give banks a choice: It offers an "off-ramp" from important regulatory requirements on the condition that they maintain a leverage ratio of at least 10 per cent (the leverage ratio measures a bank's equity capital against its assets, such as loans; currently, major banks are required to have a leverage ratio of 6 per cent.)
The idea, said Mark Calabria, an expert on financial regulation at the Cato Institute, a libertarian think tank, is to eschew hands-on regulation but to make sure, in exchange, that the banks have placed a good deal of their own money at risk. Banks aren't crazy about this idea. Mr. Calabria added that within today's Republican Party, lawmakers such as Mr. Hensarling are more likely to be sympathetic to community and local banks rather than major Wall Street institutions.
"The banking industry was not popular on Nov. 8 before the election, and it did not miraculously become lovable on Nov. 10," observed Mr. Hintz of New York University. He predicts that under Mr. Trump, some of the shackles on banks will be loosened. But he adds that doesn't mean a return to a "swing for the fences trading culture" and the "masters of the universe bankers."
'A slap on the wrist'
Even without major legislative changes to Dodd-Frank, the regulatory landscape in a Trump administration will still change dramatically.
Although regulators act independently from the White House, the president will get to choose whom he wants to police Wall Street. The current head of the U.S. Securities and Exchange Commission, Mary Jo White, has said she will resign before Mr. Trump takes office in February. And there will be several other key openings to fill next year, such as the head of the Federal Deposit Insurance Corp., a banking regulator, and the chairman of the U.S. Commodities and Futures Trading Commission, which oversees derivatives.
"The easiest thing for regulators to do is to not enforce the laws," said Barbara Roper, director of investor protection with the Consumer Federation of America, an umbrella group for national, state and local consumer advocates. "If you get government off the back of Big Business, and if you send a signal that any violations will be met with a slap on the wrist, you can see widespread violation of the law going unpunished," she said.
The widespread optimism about the future for banks under a Trump administration is, for now, mostly based on speculation. "People will get a feel after the first couple of months," said one prominent hedge fund manager in New York who declined to be identified. "Everyone assumes it will be pro-business, but nobody really knows."
Others echoed that uncertainty. Judging by the jubilant market reaction, "Everybody woke up all of a sudden and Donald is Ronald Reagan," said another hedge-fund executive, who spoke on condition of anonymity. "Well, maybe."
Mr. Trump's rhetoric is home to two competing priorities, "which actually have substantial tension – one is populism and one is deregulation," said Mr. Cohen of Sullivan & Cromwell. "How you resolve that tension is going to be important."
Some bankers are nervous about the influence of Stephen Bannon, the former chief of Breitbart News, whom Mr. Trump recently named his strategist and counsellor. Mr. Bannon turned Breitbart into a forum for the so-called alt-right, a grouping that includes people embracing white supremacist and anti-Semitic views.
A veteran of Goldman Sachs, Mr. Bannon has nonetheless issued harsh critiques of Wall Street. He has called for the industry to be held accountable for the financial crisis and described the bank bailouts as a sham.
"Those bailouts were completely and totally unfair. It didn't make those financial institutions any stronger," Mr. Bannon said at a forum on poverty in 2014, according to a transcript of the talk by BuzzFeed News. The elites responsible for the financial crisis have "never been held accountable," Mr. Bannon said. "Trust me – they are going to be held accountable."
Stephen Crowley/The New York Times
Mr. Bannon also expressed a desire for the reinstatement of the former legal barrier between commercial and investment banking. "You really need to go back and make banks do what they do: Commercial banks lend money, and investment banks invest in entrepreneurs," he said.
That's very far from the position of the average Republican in Congress, who would like to lift regulations on banks rather than institute them. What remains to be seen is how far that effort will go under a Trump administration, and whether the changes implemented could increase the risk of a future crisis.
At the heart of the mystery is Mr. Trump himself. A lifelong New Yorker, he appears to see the industry "through the lens of the people he knows there," said Mr. Calabria of the Cato Institute. "Certainly, there are people he likes on Wall Street and people he doesn't like."
Some in the industry believe that Mr. Trump's convictions on these matters are skin deep. Whatever Mr. Trump said about Wall Street on the campaign trail, "he'd give it up in a heartbeat if that means he gets something else," said the hedge-fund manager in New York. "He's going to try to do what's best for him to get a deal."
Editor's Note: A Saturday Report on Business feature on Wall Street incorrectly said Donald Trump will take office in February. In fact, that happens Jan. 20.