Fed Chairwoman Janet Yellen delivered her much-anticipated Jackson Hole speech last week. Financial markets were looking for Yellen to tip her hand on the direction of interest rates and/or the timing of the Fed balance sheet unwind. However, the most-talked about aspect of the Jackson Hole speech was her defense of regulatory reforms passed in response to the Financial Crisis of 2008:
Janet Yellen stepped up the Federal Reserve’s defense of regulatory reforms pushed through after the great financial crisis, in the face of claims from some Republican lawmakers that the regime is stifling the economy. The Federal Reserve chair said in a speech at Jackson Hole, Wyoming, that the reforms have made the system “substantially safer” and are not weighing on growth or lending. While there were ways of adjusting regulations to ensure they did not overburden institutions such as smaller banks, Ms Yellen said, she cautioned changes should be “modest” and preserve the resilience of big banks and dealers. Memories of the last crisis “may be fading”, she warned.
Her words could be viewed by some as a rebuke of President Trump who has looked askance on regulatory reforms; they could also be seen as a swan song in that it could lower her chances of being reappointed by Trump next year.
Trump’s Attack On Frank-Dodd
The U.S. economy goes through periods of economic expansion and contraction. Leading up to 2008 banks had bet trillions of their own capital on real estate and mortgage-backed securities (“MBS”). When the housing market cratered and those bets did not pay off, the systemic risks embedded within the banking system turned what could have been a recession into a financial crisis. Several banks folded or were about to fold. According to Shock Exchange: How Inner-City Kids From Brooklyn Predicted The Great Recession And the Pain Ahead Bear, Stearns’s unraveling was over the course of a few weeks:
“In the third quarter of 2007 the mortgage market cratered. In response, the Street slashed its mortgage portfolios, further driving down prices. Internally, Bear was torn about slashing its portfolio because ((ii)) the market for some securities was totally illiquid and almost worthless and ((ii)) for other securities, Bear would have to incur losses of tens of billions of dollars …”
“By early March 2008, rumors circulating the Street were that Bear was strapped for cash, creating a “run on the bank.” In a period of one week, clients and short-term lenders pulled out over $18 billion of capital and brokerages and hedge funds refused to trade with the firm.
The Fed’s response to the Bear, Stearns debacle was to aid its take over by JP MorganChase (JPM). The Frank-Dodd Act is more formal legislation established to decrease systemic risks within the financial system. It also established new government agencies to ensure the Act was being enforced. I thought Frank-Dodd combined with the Volcker Rule – designed to limit banks’ proprietary trading – was a step in the right direction to averting another financial crisis.
Inexplicably, Trump has made repealing Frank-Dodd and other regulations key to growing the economy. His sentiment is that businesses cannot grow because banks will not lend, and lending is constrained due to onerous regulations.
“Dodd-Frank is a disaster,” Trump said when he signed an executive order calling for less regulation after taking office … In a 150-page report released Monday by Treasury Secretary Steven Mnuchin, the administration calls for dismantling strict regulations overseeing Wall Street banks.
The report would hand the president the power to fire the head of the Consumer Financial Protection Bureau, an agency established in 2010 that has proven controversial on Wall Street but has been heralded by consumer advocates … Trump had given Mnuchin 120 days to come up with a plan to address what he said were onerous regulations crimping banks’ ability to lend and stifling economic growth.
In my opinion, Dodd-Frank did not go far enough. The Obama administration should have returned to the Glass-Steagall Act of 1933 and broken up commercial and investment banks. Glass Steagall worked well for 60 years and tamped down wanton speculation from investment banks – the type of behavior that led to Bear Stearns’ downfall and billions in taxpayer bail outs. Not returning to Glass Steagall was a missed opportunity for the Obama administration. If Trump’s repeal of Dodd-Frank is successful it would remove consumer protections and allow banks to engage in pre-crisis behavior.
Secondly, the tens of trillions of bail outs and economic stimulus packages handed out during the Obama administration have not necessarily trickled down to the masses. At the end of 2016 U.S. non-financial corporate borrowers had $1.92 trillion of cash on their balance sheets. This is up 10% from 2015, and more than double the amount just before the Financial Crisis. The unwillingness of businesses to spend on inventory, durable goods and new hires is likely what is holding the economy back, not banks’ unwillingness to lend.
I Am Concerned About Trump
I am becoming concerned about Trump. He is inheriting an economy that is worse than people realize. He also has fewer tools to spur the economy than his predecessor had. Secondly, he might have used up political capital and precious time by making the repeal of Obamacare one of the first things he attempted to address. Lastly, proposed tax cuts for the wealthy and repeals of bank regulations meant to protect citizens are counter to the populist message that got him elected.
Yellen’s Jackson Hole speech was a master stroke in politics. In praising regulatory reforms she might have put a negative light on Trump’s attack of Frank-Dodd. It also begs the question, “If Trump is wrong on Frank-Dodd what else is he wrong about? Is tax cuts for the rich or allowing private corporations to participate in building the nation’s infrastructure also economic folly?”
