We rarely head into the political side of things however an issue came to my attention this week. After the 2008 financial crisis then US president Barack Obama signed the Dodd-Frank Act into federal law in 2010. The Act was badly needed and was the most far reaching “Wall Street” reform since the legislative response to the Great Depression of the 1930s.
The objective of Dodd-Frank was to reduce exposure to risky financial products and to prevent the need for hundreds of billions of dollars in bank and insurance bailouts, as seen in 2008 and 2009.
The real concern is that on Friday 3rd February, Donald Trump signed an executive order requiring the US Treasury Secretary to submit possible regulatory changes and legislation to modify Dodd-Frank within the next four months.
The Dodd-Frank Act created a new regulatory body - the Consumer Financial Protection Board, which protects retail customers across the financial sector, including banks, payday lenders, credit unions and mortgage services. This helps stabilise the financial markets.
The Big Banks that were deemed "too big to fail" are subject to more capital requirements, which have forced banks to fund themselves more by raising money from shareholders rather than by borrowing.
There are more stringent rules limiting banks taking on riskier assets, which the industry itself has identified as being costly. As part of the act there are restrictions on US banks from making certain kinds of speculative investments, including investing in hedge and private equity funds, using their own money or customer deposits — so called proprietary trading.
However, Republican lawmakers have argued that Dodd-Frank is burdensome for financial institutions. Arguably the current US model remains less stringent then the Australian Model as it currently stands. Our banks of course did not fail during the GFC. Our system held up and our government did not have to bail out any banks. Reducing the regulation seems to be allowing the big banks to return to the bad old days.
It is likely that, if the Dodd-Frank act is made impotent, shares in Australian banks may well rally.
Investors need to be weary of these scenarios. During the GFC Australian banks remained strong because of our stringent regulations compared to the US. At Sothertons, we welcomed the improved financial legislative climate that rid the market of many cowboys in the industry. Call us at Sothertons for your Financial Planning needs on 4972 1300.