A Wall Street giddy over Trump should remember history

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It’s been a giddy week on Wall Street. Donald Trump’s thumping victory in the US presidential race has bankers and private equity titans dreaming that he will loosen the regulatory reins while driving up demand for dealmaking and financing of many sorts.

More immediately, the results have all but doomed the Biden administration’s efforts to impose higher bank capital requirements as well as looming new rules on everything from climate disclosure to outsourcing.

You can almost hear “ding-dong the witch is dead” playing in the background as executives enthuse about saying goodbye to Gary Gensler as chair of the Securities and Exchange Commission and Michael Barr as head of supervision at the Federal Reserve.

Private equity firms and traditional money managers are not only welcoming the end of Gensler’s multiyear regulatory blitz but also hoping that a friendly SEC will give the green light to new financial products more readily. Alternative assets, including crypto, unlisted credit and private equity, could soon be finding their way into individual accounts.

Bank executives, meanwhile, have dreams of watering down the Fed’s annual stress tests, a key limit on how much risk they can take. Investors are also betting that industry mergers such as the that between Capital One and Discover will have a better chance of getting done.

Optimists say that clearing away unnecessary strictures will stimulate growth by making it easier for banks to lend and for investment firms to channel savings into badly needed infrastructure and innovation. They also point out that regulation tends to be cumulative, and a mild pruning may be warranted to keep overall costs and red tape in check.

“Banks are back” was the way one insider described the prevailing mood. “Trump wants to ‘build, baby, build’ and that requires a lot of financing.”

Pessimists worry that the anti-regulatory tone set by Trump and his new efficiency guru Elon Musk will send competent government employees running for the exits. That could prevent the rapid regulatory approvals that the industry is hoping for, and also leave the watchdogs dangerously short of the skills needed to spot and deal with emerging problems.

“A lot of the enthusiasm is based on a false premise,” a veteran executive told me. “We now risk heading into whatever the next bubble is. Sure as hell it’s coming.”

Even if the rosy view prevails initially, longtime Wall Street veterans caution that the industry needs to be wary of pressing its advantage too far. “If you take off too much regulation, more banks fail”, and that will set the pendulum swinging back the other way, another long-timer warned this week.

The first Trump administration’s 2018 decision to ease regulations on midsized regional banks is a case in point. While most banks in that light-touch category went about their business and prospered, a few took risks that later proved fatal. Their collapse sparked the 2023 regional banking crisis. The resulting upheaval became a justification for Barr’s “Basel III endgame” proposal to boost capital requirements that the industry has just spent more than a year fending off.

The US federal system also carries built-in risks for industries that seek to completely defang their overseers. An overly conciliatory federal watchdog can create a vacuum that ambitious state-level regulators will seek to fill. Here, the history of the 2002 research analyst scandal is instructive.

When then president George W Bush named industry lawyer Harvey Pitt to head the SEC in 2001, it was an open secret on Wall Street that investment banks were wooing initial public offering clients by promising favourable analyst coverage, even to companies that had no hope of being profitable. Pitt, who promised a “kinder, gentler” style, scrubbed a planned report and convened a private meeting with the big banks where he urged them to address the conflicts of interest.

Before any reforms could be agreed, then-New York attorney-general Eliot Spitzer went public with his own investigation, sharing colourful emails that embarrassed the industry and enraged investors who were losing money in the dotcom bust. Ten banks ended up paying a record $1.4bn and agreeing to expensive structural reforms. The triumph emboldened Spitzer and other pro-regulation state AGs to bring more cases, and they remain active.

This may all feel like ancient history to the financiers who popped champagne corks over Trump’s victory this week. But they would do well to remember that finance remains a highly cyclical industry, and customers get very angry if they feel they have been cheated. Clear guardrails can serve as a shield as well as a constraint.

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