What The Financial CHOICE Act Means For You

It’s been nearly a decade since the great financial crisis and, unfortunately, many of the subsequent regulations initiated to prevent another collapse have recently been reversed. I’m talking about the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was established to ensure that the events that led to the financial crisis never happened again.

But the Republicans, who are generally anti-regulation recently passed The Financial CHOICE Act, which rolls back many regulations found in Frank-Dodd. The bill is over 500 pages long and impossible to completely understand just yet… But from what I’ve seen, here is how it affects you!

The Bureau of Consumer Financial Protection

The Financial CHOICE Act weakens the powers this specific federal department (which protects consumers against manipulative advertising and terms) and changes its hierarchy so that its director reports to the president. Now Trump can fire the director of the Bureau at will.

Easier Mortgage Lending

The bill cuts regulations to try and decrease the costs of granting mortgages to high-risk buyers. Lawmakers hope this will allow small banks to increase their lending and allow more poor credit-quality homeowners to buy home(s). This could be a good thing for Millennials though it can cause another real estate crisis in the future. As long as people don’t overreach when buying a home, they should be fine.

Repeal of the Volcker Rule

The act repeals the Volcker Rule, which limits proprietary trading and speculation by banks. Proponents of the rule say that speculation in subprime loans and other complex derivatives caused the financial crisis. Former Federal Reserve Chairman Paul Volcker argued that banks were too important to engage in speculation. Critics claim that it’s too complicated to differentiate between market making (trading on behalf of other investors) and speculation. They argue that this regulation is inefficient. Now Wall Street firms have a reason to incentivize traders to take risks and go after 7-figure bonuses. Worse comes to worse, the bank crumbles and the Federal government bails them out.

Repeal of Orderly Liquidation Authority

The great financial crisis of 2008–2009 proved that insurance companies, which were once considered low risk, weren’t. For instance, AIG nearly went bankrupt because it issued unfavorable insurance policies on highly risky (aka subprime) mortgages that eventually went sour. Before the crisis, there were only laws in place for dealing with troubled banks, not for insurance companies. Dodd-Frank established the regulations, called Orderly Liquidation Authority which helps handle the liquidation process of non-banking institutions. Critics claim that this incentivizes high risk activity and, eventually, bailouts. The Financial CHOICE Act eliminates this, which is likely a good thing for individuals.

Sayonara Fiduciary Rule

As a fee-only advisor, this means absolutely nothing to us. We’re sworn fiduciaries in every sense of the word. But unfortunately, most financial advisors aren’t. This Obama-era regulation requires financial advisors to act in the best interests of their clients while managing retirement accounts (IRAs, SEP, SIMPLE, etc). It’s pretty clear that there are substantial conflicts of interest in the retirement planning industry and the fiduciary rule helped minimize those. The rule has been on life support for a while now but this bill puts the final nail in the coffin. This will only affect you if you let it, unless your company hires a broker to manage your 401(k). Either way, you should understand exactly what you’re paying for your investment advice/retirement account. That includes management fees, trading costs, penalties, spreads, administrative costs, etc.

Fewer and Less Rigorous Bank Stress Tests

The Financial CHOICE Act reduces the frequency of these tests to biannually (from annually), which requires large banks to undergo financial stress tests… The bill will also repeal some of the more qualitative aspects of those tests. Not familiar with the details but either way, can allow certain banks to manipulate their records (by increasing/decreasing leverage and off-balance sheet assets) to conceal risk in when testing nears.

The Impact?

Overall, the bill reduces regulations, which may save up to $24.1 billion over the next decade (chump change). It allows banks and other institutions to engage in similar behaviors to that which led to the financial crisis in 2008. The bill helps Wall Street in the short-term and increases the risk of a large financial crisis in the future. Our economy, capital markets and the financial lending process is cyclical. Time will only tell how we handle the next correction. There are several provisions that, in my opinion could harm investors.

Thanks to the repeal of the Volcker rule, banks will eventually begin making riskier investments and levering up on unregulated derivatives. The same kind of behavior helped to fuel the financial crisis a decade ago. And with fewer and less rigorous stress tests, banks will have more room to manipulate their risk profile and go unnoticed.

Also repealing the OLA may actually have the opposite effect of what’s intended. Without OLA, the Gov may not have the mechanisms required to deal with troubled banks or other financial institutions and may not have any choice but to bail out troubled companies to prevent a larger, more intense crisis.

The next step is for the Senate to pass a form of the CHOICE Act. The Republican party holds a slimmer majority in the Senate, but some provisions such as the Volcker rule may be left out.

For now, it’s waiting game.