How President Trump could dismantle Wall Street reform

For years, Wall Street has complained that restrictions placed on the industry after the financial crisis went too far and were too costly. Those concerns didn't generate much sympathy - until now.

President Donald Trump has opened the door for sweeping changes to the way financial institutions - big and small - are regulated. He signed an executive order calling for a review of the laws that govern the U.S. financial system in an opening bid to upend the Dodd-Frank Act, the financial reform legislation passed in 2010.

Banks and other financial institutions are dusting off their wish lists in hopes of trimming, if not killing, some of the most costly portions of the law. The country's biggest banks will spend $100 billion over the next five years complying with regulations, said Mike Mayo, a banking analyst with CLSA, a boutique investment firm.

"Dodd-Frank was enacted to prevent another financial crisis," Mayo said. "And it was done quickly and with purpose, but it was not done efficiently for the industry."

Of course, dismantling the legislation will not be easy. It took more than a year to pass and comprises hundreds of regulations issued by more than half a dozen agencies. Some pieces of the bill required the approval of several federal agencies and would be cumbersome to revisit. After hiring thousands of people to help digest the new rules, some big banks say they are not looking for another time-consuming change.

Large financial institutions now must hold onto more capital, a measure of a bank's ability to absorb losses, and endure yearly "stress tests" to prove that they could survive economic calamity. But that hasn't stopped some from getting bigger anyway. JPMorgan Chase now has nearly $2.5 trillion in assets, up from about $2.2 trillion in 2008. Wells Fargo has grown even faster, now holding $1.9 trillion in assets compared with $1.3 trillion in 2008.

"We're not asking for wholesale throwing out of Dodd-Frank," Jamie Dimon, chief executive of JPMorgan Chase, said at a financial services conference in December. James Gorman, chief executive of Morgan Stanley, told CNBC recently: "I'll be very clear about this, I'm not a fan of getting rid of Dodd-Frank."

Rather than starting over, industry leaders say, they would rather tweak the framework Dodd-Frank created. Some of those changes will require congressional approval, but others may be easier to accomplish through the business-friendly regulators Trump is expected to appoint than by enduring a bruising battle in Congress. Small community banks, for example, are hoping regulators will more explicitly exempt them from cumbersome rules developed for Wall Street giants.

"There is a lot that can be done with new personnel," said a senior financial industry official, who like others in this article spoke on the condition of anonymity in order to talk frankly.

Even insiders wonder what is ahead. Here is a guide to the areas of Dodd-Frank most likely to be rolled back during the Trump administration:

Restrictions on risky trading

Dodd-Frank touches nearly every aspect of the way banks operate. But one of the most controversial ones has long been the so-called Volcker Rule, which aims to prevent large, federally insured banks from making risky financial bets. Financial institutions that make loans and collect consumer deposits, such as checking and savings accounts, shouldn't be taking on the same type of risks that hedge funds and private-equity firms may, supporters of the rules say. Limiting those activities help keep the financial system safer, they said.

But problems began to mount as regulators tried to distinguish between speculative activities, known as "proprietary trading," which the rule intends to limit, and other types of activities such as "market-making," in which banks buy and sell securities to clients, or hedging, in which banks attempt to offset risk in their holdings.

The banking industry says the rule, which is named after Paul Volcker, former chairman of the Federal Reserve, is too complex and has been improperly applied to small community banks.

Dimon famously criticized the rule, saying regulators would need a psychiatrist to help determine whether a trade was proprietary.

Dimon once famously warned that "for every trader, we are going to have to have a lawyer, compliance officer, doctor to see what their testosterone levels are, and a shrink - what is your intent?"

"The intent behind the Volcker rule is a good one," Mayo said. "The execution is riddled with red tape, complexity and lawyers."

But there is another factor: A 2014 report by the Office of the Comptroller of the Currency, a financial regulator, found that the rule would cost national banks as much as $4.3 billion to implement as they would have to sell some investments at a loss. That doesn't include the billions that banks would potentially lose by not being able to make these bets, industry officials say.

Some Republicans want to ditch the provision all together, which would require legislation and is likely to spark a fierce fight with Democrats. But Steve Mnuchin, a former Goldman Sachs banker who Trump has nominated to be Treasury secretary, appears to be leaning toward coming up a compromise.

"I support the Volcker Rule, but there needs to be proper definition around the Volcker Rule so banks can understand what they can do and what they can't do," Mnuchin told the Senate Banking Committee last month.

The consumer watch dog

One of the signature achievements of the Dodd-Frank law was the creation of a new agency: the Consumer Financial Protection Bureau. Since its creation, the CFPB has crafted hundreds of new rules for mortgage lenders, banks, credit card companies and other financial institutions.

It has also repeatedly found itself in the crosshairs of Republicans in Congress.

"The CFPB is arguably the most powerful, least accountable agency in U.S. history," Rep. Jeb Hensarling, R-Texas, head of the House Financial Services Committee, said in a Wall Street Journal column. "The agency defines its own powers and can launch investigations without cause, imposing virtually any fine or remedy, devoid of due process."

The CFPB is led by one person, Richard Cordray, and is funded through fees collected by the Federal Reserve. That limits Congress' ability to provide oversight of the agency. If the CFPB was led by a bipartisan commission and funded by a congressional appropriation instead, for example, lawmakers could use that process to exert pressure on the agency to focus on different types of cases.

Outrage at the agency has culminated in efforts by Republicans to urge Trump to fire Cordray before the end of his term next year. (Hensarling has proposed finding a way to defund the agency.) Democrats have mounted aggressive efforts to save Cordray's job, but adding to CFPB's problems is a federal appeals court decision last year that found the agency's structure unconstitutional. That decision is being appealed.

While some industry officials and Republicans would like to get rid of the agency altogether, that appears unlikely. "This is a tricky one, there is a lot of bipartisan support for the [CFPB], there is no support to abolish the place," said the senior financial industry official. But "there is definitely some support for doing some governance" reform to change how it is run.

Executive compensation

Dodd-Frank also includes measures targeting the way corporate executives are paid. They are among the rules most despised by the business community and have already faced increased scrutiny.

The legislation, for example, restricts the ability of banks to hand over large bonuses to executives who made risky bets on the markets - and gives them the right to claw them back after the fact.

Industry officials have complained the rule is confusing and doesn't recognize the changes big banks have already made to their bonus structures. But, again, getting rid of this provision would require an act of Congress and would meet a lot of resistance from Democrats.

In another case, Trump's acting Securities and Exchange Commission chairman Michael Piwowar is already acting. Piwowar has ordered a review of a rule that went into effect last month that requires companies to disclose how much their CEOs earn compared to their employees. The rule could reveal a potentially embarrassing disparity between the paydays of millions of workers and their top bosses. It is favored by labor groups, but is called unnecessary by the business community.

"The point of this ratio is simply to advance an agenda that says executive compensation is too high and embarrass people," said Bill McLucas, a securities lawyer with WilmerHale, who spent eight years as SEC enforcement chief.

A powerful panel

A change may also be coming for a powerful group created by the Dodd-Frank Act: the Financial Stability Oversight Council, or FSOC. It is comprised of the leaders of the country's primary financial regulators, including the SEC and Federal Reserve, and is led by the Treasury secretary. The council is tasked with identifying and attempting to address risks to the financial system before they can damage the economy.

But banking industry officials have complained that FSOC is opaque and operates a "blunt instrument," according to one financial industry official. The panel is too focused on developing new rules rather than streamlining the ones already put in place, another said. Rather than doing away with FSOC, some industry officials want to see it change its focus and explain its decision making more explicitly.

"There is a sense in the industry that it should be easier to understand what they are doing and why they are doing it," said David Portilla, a partner at Debevoise & Plimpton, who served as a senior policy adviser to FSOC in 2012 and 2013. "The administration could refocus FSOC on streamlining regulations rather than increasing regulatory burdens as it has been."

Among FSOC's most contested powers is to designate a company as a "systemically important" financial institution - informally called "too big to fail" - and worthy of additional scrutiny because it could pose a grave risk to the economy in a crisis. In 2014, the panel added AIG, Prudential, General Electric's financing arm and MetLife to that list. None is a bank, but each is so large and complex, the council found, that if it failed it posed a danger to the financial system.

MetLife sued, arguing that FSOC did not properly assess the insurer's financial strength, noting that the company does not engage in the type of risky behavior that could rattle the economy. Last year, a federal district judge sided with the New York-based firm. The case is being appealed, but the Trump administration could drop it or take other steps to loosen regulations of these firms.

Community banks are ready for relief

Dodd-Frank was designed primarily to rein in large Wall Street firms. But small and medium-size community banks say they have been crushed under new regulatory burdens since the financial crisis.

A lot of community banks are in rural areas that Trump won, said Paul Merski of Independent Community Bankers of America. They are now looking to the Trump administration for relief, he said. "We kind of got swept up by the Wall Street meltdown," Merski said.

The changes smaller banks want vary, but come down to a simple principle: They shouldn't face the same sort of rules as megabanks such as Goldman Sachs or Bank of America.

"Regulation shouldn't be one size fits all," Merski said. "You shouldn't have the same regulatory burdens on a community bank, which has a simple business model, that you have in a trillion dollar institutions. If a community bank fails, it is not going to bring down the financial system."

These banks, for example, want to raise the $50 billion asset threshold at which banks face tougher oversight. That should be raised to $250 billion, industry officials say. Also, the CFPB is considering a new rule requiring banks to comply with the same reporting requirements when making a small business loan as they do with a mortgage, Merski said. That extra paperwork, and the threat of facing prosecution or a fine if it is not filed correctly, will scare some banks away from making small business loans, he said.

"If this could be stopped it would help a lot of people," Merski said. "Banks operate on a small margin, every penny of additional staff you have to hire" to keep up with new regulations hurts.

Bankruptcy without disaster

One of the clearest lessons of the financial crisis is just how difficult it is to put a large, complicated financial institution through bankruptcy. Under Dodd-Frank, troubled banks that are too complicated for the regular bankruptcy process would fall under the "Orderly Liquidation Authority." This provision gives a regulator the ability to declare a company's failure risky to the financial system and take over. The Federal Deposit Insurance Corp. would run the process rather than a judge and could lend the company funds and take other steps to prevent its financial problems from bleeding to the rest of the financial system.

This provision also gives regulators the ability to collect fees from banks to recoup any costs incurred in unwinding the financial institution. That way taxpayers would not be stuck picking up the bill.

But critics say the process is cumbersome and object to the collection of fees from other banks. Instead, they say, this provision of Dodd-Frank should be eliminated and the U.S. bankruptcy code should be updated to handle more complicated cases.

"What matters more than anything, at this point, is that we figure out an approach to resolution that is not just a hope, and which will in fact reduce systemic fallout, said Kurt Schacht of CFA, an association of investment professionals. "We are concerned we are not there yet under" Dodd Frank Act.