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Sunday, February 26, 2017

President Trump orders review of Dodd Frank Act



Among the slew of executive orders that President Trump signed in his first few weeks in office, was one directing the Treasury secretary to submit a report on the review of Dodd-Frank Act (DFA) and recommend changes in 120 days. I believe this is a step in the right direction to resetting complex banking regulations and ease credit flow and kick start the economy. In this context, it is worthwhile to understand the importance of this law and how it has impacted the financial services industry in a post-recession America.

The banking and financial services industry in the US contributes over 8% of the GDP and is considered as the life blood of the business and economy of the country. Because of the big economic impact banks have on the economy, it is no surprise that it is also one of the most highly regulated industries in the US and probably in the world. Hence the need for prudent regulations is understood and justified. Therefore, the laws that govern its growth and welfare are expected to be living documents and subject to periodic changes so as to be relevant in a dynamic environment. Hence the executive order to review the DFA is a welcome initiative.


The DFA is a big legislation. It is indeed a massive piece of law that runs over 2300 pages incorporating more than 400 rules and mandates. It can be broadly divided into eight key pillars that seek to protect the consumers and regulate the financial markets.



Among the key provisions in DFA, are the creation of the Consumer Financial Protection Bureau (CFPB) -which is responsible for implementing and enforcing compliance with consumer financial laws, stringent regulatory capital requirements, significant changes in the regulation of over the counter derivatives, reforms that regulate credit rating agencies, changes to corporate governance and executive compensation practice and the Volcker Rule ( which bans banks from using or owning hedge funds for their own profit).

The provisions in the DFA were designed to create and sustain a safe and sound banking industry. For instance, the enhancement of the capital requirements of banks created sufficient cushion to absorb loan losses in an unfavorable economy. It also mandates banks to keep a significant portion of their assets in cash and government securities so that they could be easily liquidated in the event of a run on the bank or fast deteriorating macro-economic conditions.

It is easy to see the good intent of the Act. But the experience of banks, regulators and experts since 2010 have been very mixed.  As would be expected, experts in the field have sharply divided views on the efficacy of the Act in achieving its stated goals.

The Dodd-Frank Act had an acrimonious birth and had sharply divided influential Senators and Congressmen. While President Obama claimed victory, the Republicans then had warned that this massive piece of legislation would arrest the flow of credit and slow down recovery and impact job creation.

DFA was enacted to safeguard the consumers and prevent a repeat of the financial crisis of 2008. One of its important objectives to end ‘too-big-to-fail’ banks. But what has the DFA achieved in six years? The ‘too big to fail banks’ remain intact. On the other hand, it has adversely impacted small and medium banks by imposing a heavy regulatory burden on them. 

A study by American Action Forum published in 2016 found that the DFA in six years had cost a total of $36 billion – including $10.4 billion in its sixth year of existence. The study further showed that in the six years, DFA has resulted in a burden of 73 million paperwork hours. DFA has indeed been a logistical nightmare for banks.

A Harvard study on the impact of DFA found that the top five bank-holding companies control nearly the same share of U.S. banking assets as they did in the fiscal quarter before Dodd-Frank’s passage. But community banks with $1 billion or less in assets have seen a significant decline.

It would be pertinent for me to point out here that often in their zeal to protect consumers, legislators tend to over-regulate to the point of almost killing the industry.  Human history is replete with instances where laws are often enacted as a knee-jerk panic reaction in the aftermath of a crisis. But these very same legislations are rued over by the same legislators when the crisis has passed and the severity of their actions dawns on them. We have seen this happen periodically in America, Europe and elsewhere. Is it the legislators’ curse on the democratic world - killing us with their concern and zeal?

As a former bank regulator, I have been an advocate of minimum and prudent regulations that achieve the stated goals by imposing minimal financial costs on banks and regulators. Complying and supervising well-intentioned legislations must not by itself be a Herculean task. I have always believed that DFA has been a logistical and expensive nightmare for the bankers and the regulators. To pass the smell test, a law has to be simple, unambiguous, easy to implement and enforce and achieve its stated objectives with ease. On all these counts, in my view, the DFA fared poorly.  

But that is not to say that I advocate the repeal of the law. By no means.  The Feds need enabling and powerful laws to maintain a disciplined financial system where banks power the engines of growth by funneling credit flows to big and small consumers alike to achieve sustainable business growth. The review is a welcome move and hopefully make DFA easier and less expensive to comply.

The Trump administration has to exercise caution to not bring in legislations that are too big and expensive to administer, comply and enforce and carry the risk of collapsing under its own weight. The incoming administration has a great opportunity to make a big difference. President Trump has taken the right steps to review the Dodd-Frank Act.

Friday, January 20, 2017

Britain’s Hard Brexit Strategy – Unraveling of the European Union?



In a hard-hitting speech on the 17th of January 2017, British Prime Minister May clearly spelt out the country’s stand on Brexit. She made it clear that the UK will come out of the single market as well as the customs union and promised to build a truly “global Britain” that would reach out beyond Europe to build  “new partnerships with old friends and new allies”.  Mrs. May cited discontent over directives coming from Brussels that weakened local democracy, tensions over jurisdiction of the European Court of Justice, record immigration et al – all of which fueled the Brexit vote last year – as the driving factors for Britain’s decision. 

Prime Minister May underscored Britain’s relationships across the world, specifically outside Europe.  She hinted that Britain would revitalize trade relations with erstwhile British colonial ecosystem of the mid-twentieth century and seek to regain its preeminence as a great trading nation. Specifically, she talked about the new trade negotiations underway with Australia, New Zealand and India to drive home the point that Britain will not be seriously impacted by Brexit.

Mrs. May also warned the EU against resorting to “punishing” the UK. This, she warned, would be calamitous for the Union.  Not surprisingly, the hard-hitting speech was meant for the local British constituency as well as the EU, particularly Germany and France who have advocated a tough line against Britain. Following last years’ referendum in Britain, there has been a lot of sound, fury and venting from Europe. Worried that other countries may follow Britain, several EU ministers had demanded punitive measures that would showcase to other nations that leaving the EU could be an expensive  affair.

The Prime Minister’s speech did not wave an olive branch as many observers had expected. It definitely looked more like a resolute leader preparing for war. Indeed, the Brits appear to have done their homework and are prepared to take big risks.

Two developments that have spawned the new-found confidence in PM May are the election of Donald Trump as the President of the US and the resilience of the British economy in that order.
The election of Donald J Trump as the US President has an obvious role in the tough stand on Brexit. Trump has been a vocal supporter of Brexit. He has also come out openly in support of the UK. His opposition to Transatlantic Trade Partnerships is also well known.  

Secondly, the strong performance of the economy is a key factor that has emboldened PM May. Data on the performance of the British economy in 2016, and in particular post Brexit is indeed revealing. Most European nations, including Britain, continue to face a sluggish economy. But latest statistics released by the Office for National Statistics (ONS) shows that Brexit, by and large has had minimal impact on the UK. For example, unemployment was at a record low – in fact the lowest in a decade. Unemployment fell by 52,000 to 1.6 Million in the three months post Brexit. Per the ONS, unemployment hovered at 4.8% - a 11 year low. Average weekly earnings excluding bonuses increased by 2.7% compared to a year earlier. Overall employment rate hovered at an encouraging 74.5%

In an update to its biannual World Outlook published on 16 January 2017, the International Monetary Fund (IMF) has forecast that the British economy will grow by 1.5 percent this year, 0.4 points more than expected in October, after 1.6 percent growth in 2016. The IMF says that  "domestic demand held up better than expected in the aftermath of the Brexit vote". But it has revised its 2018 forecast for the UK down by 0.3 points to 1.4 percent growth.

I have maintained all along that Brexit will have negative consequences only in the short term and had disagreed with many pundits who talked about a collapse of international trade and globalization. Brexit is a trade dispute between the UK and the EU and projecting this as a global trade malaise is an exaggeration. It is a local contagion and will have minimal impact on world trade. 

Britain has had a complicated relationship with the EU. The EU continues to be dominated by Germany and France giving it little say. The UK has always harbored an ambition to re-emerge as a world leader and has consistently sought to use every opportunity to project its military, political and economic leadership. Given this agenda, it would be only logical to not expect the UK to play second fiddle in the EU for long.

While the bravado may be applauded back at home, the UK is definitely taking a big risk. Non-EU exports for November 2016 stood at $18.6 billion while EU exports stood at $17.34 billion. On the other hand, non-EU imports stood at 24.2 billion while imports from EU stood at $28 billion. (Data: UK Trade Info). In other words, give or take,  50% of UK trade is with EU. This is a sizeable chunk and the UK will have to work hard to protect this trade.

I am of the view that human ingenuity and innovation will take the lead in crisis situations. I had already expressed this in my earlier piece. My guess is that a new trade deal will be carved out by the UK with its “old friends and new allies”. It is too early to predict an unraveling of the European Union. But suffice it to say it will no longer be the same again. But from what appears in my crystal ball, I can safely say a new trade order and tariff regime is in the offing.

The powerful economies of China and India have been bystanders to this awesome spectacle called “Brexit”. Britain seems to be working overtime to woo these two economic power houses. And rightly so as any future trade grouping and tariff regime can no longer ignore them. 

For now, Brexit is not truly any exit. It is the ushering in of a new era in international trade.

Sunday, July 3, 2016

The hype over #Brexit



The newspapers, TV and internet sites are all about it. In case you woke up late and missed it all, we are talking about BREXIT, a hashtag that was trending in twitter for long. The Brits voted in a referendum to leave the European Union or EU. Many have called it a devastating and shocking development that could plunge the world into economic chaos.  True – David Cameron the British Prime Minister plans to step down as stock markets around the world went into a cold shudder. The NASDAQ, DJI, S&P in the US reacted nervously and hit negative territory.

Donald Trump, the presumptive Republican Presidential nominee voiced his opinion too. He called it a victory for UK “since the people had taken back their country”.  However, other US leaders on both sides of the aisle were cautious in their response. If the US response was cautious, it had good reasons to be so. It reminded Washington and Capitol Hill of the fragility of the European Union and warned of a potential exodus by other states. An already weak Europe caught in the Brexit crisis, has stoked fears of a full blown European recession and similar consequences on the US economy.  Many European and world leaders worried that if a special US ally like UK could exit, there was no stopping other countries.

Markets in Europe and Asia also reacted negatively to the will of the Brits, it appeared. All this reaction was in response to the referendum result. The UK referendum itself was unprecedented. With the highest turnout since 1992, 72% came out and had their say with 51.9% voting to ‘Leave’ and 48.1% wanting to ‘Remain’. The referendum also showed the geographic split -Brits wanting to ‘Remain’ were concentrated in London, Ireland and Scotland areas whereas the hinterland was rooting to ‘Leave’.

To start with, Brexit itself is at the heart of a complex problem. Many have attributed it to the large influx of immigrants in the recent past as the trigger. In a bad economy, the influx has only aggravated the pressure and really tested the very concept of the ‘welfare state’. Per data released by the Britain’s Office of National Statistics net migration to the UK reached a record 330,000 in the year ending March 2015 while the size of the foreign-born population reached 8,277,000. Many have opined that this could stress the government and infrastructure. For example, the net influx would put pressure on an already aging UK water supply system, not to mention the increase in students enrolled per class in the primary schools.

The referendum also had important lessons for other European nations like - France, Germany, Denmark where nationalist movements have gained strength in the recent past as a reaction to the flood of immigrants.

It may be hard for many to imagine that a net influx of 330,000 migrants could tip the scales in a developed economy like UK.  That number may be small by the standards of the US or other large population centers elsewhere in the world. But it has to be conceded that for a small geography like the UK, these numbers are significant. This issue, has been the last straw on the camel’s back and has created the chasm that has polarized the UK. ‘Remain’ activists have accused the ‘Leave’ activists of xenophobia which in turn has only fueled the growing gap. But the truth is that a long running recession leading to near desperate economic conditions provided the fuel and immigration the spark to ignite the Brexit bomb.

Many observers have raised fears of a recession in Europe and potentially in the US too as a direct consequence of Brexit. The nervousness in stock markets around the world has only accentuated this fear. Some have even predicted the end of globalization and a collapse of international trade.  Others have pointed out that the falling UK currency – the pound - has its own benefits like making exports cheaper and attracting more tourists to the UK. All this may be true in the short run. But I will not bet on the fall of the pound over the long run and hence these benefits may be short lived.

Will Brexit spawn these severe consequences as many fear?  For sure, opinions are deeply divided. First off, much of the fears of a disaster are impulsive reactions and as often happens in such cases, are exaggerated. The stock and currency markets will stabilize soon. Many of the uncertainties we fear today are over the short term.

Truth is that global trade is in the throes of reinventing itself. Brexit, in all probability, portents to the emergence of a new trade order and tariff regime. The crisis itself can catalyze the emergence of new trading paradigms or partnerships – bilateral as well as multilateral - that more accurately reflect the global economic and trade realities, rather than proximity, political and militaristic calculations. There are historical parallels and the emergence of EU itself was a product of such negotiations.  In this context, it is worth pointing out that many of the extant trade blocks and treaties as well as those in the works exclude some heavy weight economies like India and China and hence by definition are not representative of economic and trade realities. For example, Brexit could engender a new trading block that includes UK, Japan, Germany and India sooner than many have imagined. Any permutation of economies that are bound by mutually beneficial trade could emerge.

When we step back and take a 30,000 feet view of the Brexit crisis, we see one country has filed for divorce from a trade alliance. The UK is not the United States in terms of geography or size of its economy. Both the EU as well as UK will continue to trade with each other, albeit in a different tariff regime, and with the rest of the world. Hence painting a doomsday scenario is untenable and devalues human ingenuity and the genius to execute profitable global trade.

The emerging economies of Asia, specifically India and China, will continue to trade with UK and EU. So by no means this is the end of globalization or global trade. In fact, the world will suck up Brexit and move on, faster than many have imagined. Nor will the world go into recession.

Having said that, in all probability, UK businesses in the short to medium term will suffer adverse economic and trade consequences. The Bank of England may lose some serious treasure defending the pound.  But human ingenuity and survival instincts will prevail and new beneficial bilateral trade deals will be worked out.