A Financial Reform Plan for Trump

Crucial for stability.

Photographer: Andreas Solaro/AFP/Getty Images

Come Jan. 20, President-elect Donald J. Trump will start carrying out his agenda. How does he expect to turn promises into policy? Do his plans make sense? If not, what should he do? Finally, given the political realities of Washington, what’s most likely to happen? This is part of a series of editorials that try to answer these questions.

What he says he’ll do: Trump’s plans for the financial system aren’t easy to divine. In his public statements, he’s promised both deregulation and re-regulation. He says he’ll scrap the Dodd-Frank legislation and reinstate the post-Depression-era division between commercial and investment banking -- a “21st-century Glass-Steagall,” he calls it. Despite the mixed messages, one main idea seems clear: Get rid of the current complicated system and replace it with something simpler.

Does that make sense? Partly. Simpler would be better, and Dodd-Frank is excessively complicated. But implementing a new Glass-Steagall would be no more straightforward. Complex and burdensome regulations are needed when financial rules lack one crucial element: equity capital, the money financial institutions get from their shareholders. Unlike debt, equity absorbs losses automatically, a feature that can make the entire system more resilient. Better-capitalized banks would have helped avoid the financial crash.

What he ought to do. Deregulate -- but only after requiring institutions to finance themselves with more capital. Suppose banks had at least $20 in equity for each $100 in assets. Shareholders would have a greater incentive to monitor risk, the chances of distress would be lower, and the economy would be better off. Financial institutions could be released from a litany of onerous regulations, including annual stress tests and living wills.

The most likely outcome: It’s hard to say. If Trump offered that bargain, banks would probably resist: They prefer to use more debt, because it comes with taxpayer-backed subsidies (such as deposit insurance) and can boost measures of profitability such as return on equity. That said, the idea of focusing on capital is gaining support, most notably in a plan unveiled Wednesday by the Federal Reserve Bank of Minneapolis -- and also in a flawed Republican blueprint called the Financial Choice Act. Much will depend on Trump’s choice to lead the Treasury Department, but don’t bet on the right kind of deregulation any time soon.

To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net.