If you’ve been paying attention to the Trump administration’s economic plans, you might have heard phrases like “Dodd-Frank” or “fiduciary rule,” along with threats to repeal or change them. But unless you’re already familiar with these issues, chances are you ignored them in favor of something more sensational. And who can blame you? These issues are intentionally turned into technobabble snooze fests so that citizens will ignore them. Or, worse, politicians will play to your emotions by claiming that regulations “limit choice” or “reduce freedom.”
The truth is that the financial industry needs to be regulated, in some form or another.
Deconstructing the Dodd-Frank Act
Obama signed the Dodd-Frank Act into law in 2010 as a response to the financial crisis of 2007-2008. The law is massive and its impact on the financial industry has been significant. One of the most significant parts of the law requires banks to carry an increased amount of cash, while also limiting the amount of risky assets they can hold. The logic is that should another financial crisis strike, the banks will be able to bail themselves out, rather than depend on government (taxpayer) money.
In early February 2017, Trump ordered a review of the Dodd-Frank Act, with the expectation that the law will be repealed or significantly scaled back. In the short term, this would benefit bank executives and shareholders, who would see their earnings and pay increase. In the long term, it would significantly increase the instability and danger in our financial system because it would allow for a return to the environment that led to the financial crisis.
Muir Woods, just outside of San Francisco.
Figuring Out the DOL Fiduciary Rule
The Department of Labor fiduciary rule is a separate, more recent issue. Developed by the Department of Labor, the rule essentially forces financial advisors and brokers to act in their clients’ (this is you) best interests. Sounds like common sense, right? But currently, advisors and brokers can invest your money in funds that pay them a kickback, or excessively trade to generate fees. They are acting in their best interests, not in yours, despite the fact that you depend on them to save for retirement and build a financially stable life.
The fiduciary rule isn’t in effect yet. It was supposed to take effect in April 2017, but Trump ordered a delay. At the time of this writing, it is set to go into effect in June 2017, but many expect it to be delayed again, and there is some risk that it will be killed.
Of course, there are a couple of caveats to all of this.
Because the Department of Labor created the fiduciary rule, it only affects financial advisors who are dealing with retirement accounts (i.e., 401k, 403b, IRAs, and so on). So, advisors and brokers who are dealing with taxable accounts or Roth IRAs will not be effected and can continue to operate in their own best interests. There’s also some criticism that the fiduciary rule should have come from the Securities and Exchange Commission (SEC) — which would have allowed it to target all investment accounts, not just retirement accounts. But the SEC was dragging its feet and Obama pushed the Department of Labor to move forward.
More importantly, there are financial advisors whose business model is built on being a fiduciary and always acting in their clients’ best interests. These are called registered investment advisors (“RIA” for short), and if you’re in the market for a financial advisor, then I recommend hiring an RIA.
Why This All Matters
Regarding the Dodd-Frank Act, it is true that the law has hurt small banks, which have a hard time dealing with the increased costs imposed by the law. This has had knock-on effect, making it harder for small businesses to get loans. It’s also true that the law is huge, unwieldy, and complicated. But without some form of regulation, the conditions that led to the financial crisis would still be in place.
If the financial industry were incentivized differently, perhaps regulations wouldn’t be necessary. That would include long-term compensation, and the industry would have to share in the gains and losses of its clients (it would need to have skin in the game). At the moment, most compensation packages are too short-term, and it’s too easy for the industry to do well while its clients suffer. I’m not proposing specifics; there are probably dozens of different ways to change incentives. But until that happens, regulation is necessary to keep the worst of the industry in check.
One exciting development: There is pressure to reinstate the Glass-Steagall Act (check out “Why You Should Care” for a brief review of the law). The movement has bipartisan support, especially from Senators John McCain and Elizabeth Warren, and the idea is that the clunky, complex Dodd-Frank Act would be replaced by the comparatively cleaner and simpler Glass-Steagall Act. The law would essentially break up the big banks, making them smaller and less likely to cause global crises. It’s likely the industry would push back on this — just like it pushes back on Dodd-Frank — but it would be an improvement.