Hillary's Plan to Save Wall Street Could Punish Main Street
By Larry Tabb, TABB Group
Originally published on TABB Forum
While many of the planks in Hillary Clinton’s plan to avoid the next crash on Wall Street already have been rolled out as part of Dodd-Frank or are in the process of being implemented, her proposal includes a few wild cards. Depending on how they are implemented, they could have very negative impacts not just on the financial markets, our pensions and retirement plans, but on Main Street as well.
“Seven years after the financial crash, despite important new rules signed into law by President Barack Obama, there are risks in our financial system that could still cause another crisis. Banks have paid billions of dollars in fines, but few executives have been held personally accountable. ‘Too big to fail’ is still too big a problem. Regulators don't have all the tools and support they need to protect our economy. To prevent irresponsible behavior on Wall Street from ever again devastating Main Street, we need more accountability, tougher rules and stronger enforcement. I have a plan to build on the progress we've made under President Obama and do just that.” –Hillary Clinton, “My Plan to Prevent the Next Crash,” Bloomberg View
In reading over Hillary Clinton’s plan, published on Bloomberg View, to avoid the next crash on Wall Street, many of her planks already are part of Dodd-Frank, and they either have been rolled out or are in the process of being implemented. That said, her proposal includes a few wild cards, and depending on how they are implemented, they could have very negative impacts not just on the financial markets, our pensions and retirement plans, but on Main Street as well.
To quickly review the new rhetoric on things already done or in the works, Hillary calls for new fees on risk taking, enforcing the Volcker Rule, recapturing compensation from senior managers at problematic banks, and the break up banks that are too big to fail. Unless Hillary is talking about nits and gnats, most of these rules and practices have been, or are in the process of being, implemented through Dodd-Frank and Basel III.
Unfortunately, there are a few other aspects of her platform that could be dangerous, including “discouraging excessive leverage and short-term borrowing,” “stronger oversight of the ‘shadow banking’ sector, which includes certain activities of hedge funds, investment banks and other nonbank finance companies,” and the imposition of “a tax on the high-frequency trading that makes our markets less stable and less fair.”
While these three points sound like they are the foundation for a Motherhood and Apple Pie platform, how they are implemented could have a dramatic impact on the U.S. economy, jobs and America’s global competitiveness.
First, depending on where you draw the line, discouraging excessive leverage and short-term borrowing reduces liquidity and increases volatility. Historically, investment banks use repurchase agreements to add leverage to their balance sheets, which did get Lehman Brothers, Bear Stearns and others into tremendous problems. Basel III gets to the heart of this problem by forcing banks to have more capital, reduce leverage and make the banking sector safer. It also gives provisions to the regulators to declare risky non-banks systemically important and treat them like large banks, ensuring they don’t get into too much financial trouble (or risk being resolved).
Now, if Mrs. Clinton is simply reinforcing support of Dodd-Frank and Basel III, that’s one thing. But if she wants to ratchet up the level of capital and leverage controls, that’s a horse of a very different color.
Volcker and Basel III already have been blamed for reducing liquidity and increasing volatility in our markets. As the banks move away from making markets and providing liquidity, that service is transferred to firms that generally supplant liquidity with speed. Instead of fewer larger trades, computers break trades into smaller ones and flip them more quickly. The market maker/liquidity provider holds less risk, but prices adjust much more quickly while these less capitalized entities more nimbly step away from the markets when machines don’t understand how to trade. There are multiple cases in point, including the May 6, 2010, Flash Crash, the May/June 2013 Taper Tantrum, the Jan. 15, 2015, SNB reset, and the Aug. 24, 2015, ETF turmoil.
Reducing the ability to provide liquidity makes our markets more volatile, pushes risk to investors and accelerates flash crash-type scenarios. This scenario will be especially poignant given a draconian implementation of the second two issues proposed by Clinton: greater oversite of shadow banking and increased taxes on high-frequency trading firms.
As banks move away from trading and risk shifts to less-capitalized intermediaries and investors, it makes understanding what these non-bank players do, their solvency and how much risk they take more important than ever before. If bank trading desks are shuttered and reopened as fully capitalized, non-bank dealers, prop shops or hedge funds, regulators need to have a general understanding of systemic risk.
However, as banks shutter desks, it becomes more important for non-banks to provide liquidity and stabilize markets; otherwise, companies have a more difficult time getting financing, creating healthier companies and developing new jobs.
While regulation of these entities is important – and precluding the next Lehman or Bear Stearns is critical – overregulation or layering on transaction/cancellation taxes makes it less efficient to provide liquidity, compounding the challenging risk-provisioning transition from banks to non-banks.
If the primary aim of bank regulation and leverage rules is to avoid bank bailouts, and there are no provisions to bail out non-systemically important non-banks, prop shops, or hedge funds, then why would Mrs. Clinton want to impose the same capital and trading guidelines on a non-bank/non-guaranteed entity?
Layering on the same rules for non-deposit, non-guaranteed entities not only will preclude banks from providing liquidity (the grease that makes the financial markets operate), it also will chase non-bank liquidity provisioning and risk capital away from the market, making markets more volatile and turbulent at the exact time when we need liquidity the most.