Could Repealing Dodd-Frank Make the Derivatives Market Even Bigger?

Rachel Gearhart
by Rachel Gearhart, Managing Editor

 

dodd frank derivatives market 1

Last month, three of the most powerful people in the world met in Jackson Hole, Wyoming.

Bank of Japan Governor Haruhiko Kuroda, Federal Reserve Chair Janet Yellen and European Central Bank President Mario Draghi - let’s call them the Big Three of monetary policy - had a lot to discuss.

One item that almost certainly came up was the possible repeal of Dodd-Frank... and its effects on the already huge derivatives market.

Yet the only question many people seem to be asking is “Is this Yellen’s last Jackson Hole conference?”

Yellen’s Last Stand?

You see, Yellen’s four-year term as Fed chief expires in February. She could be reappointed to a second term, yet it’s no secret that she and President Trump have a love-hate relationship. There are rumors that Trump’s economic advisor - Gary Cohn - will replace her.

But too many people are asking the wrong question. The question should be “What will happen if Dodd-Frank is eliminated?”

If Cohn does get the job as Fed chair, it may become a whole lot more likely that the Dodd-Frank Act will be repealed. That would do away with the contentious regulations imposed on banks.

And it could allow our massively overgrown derivatives market - the subject of this week’s chart - to get even bigger.

(True, the Fed can’t pass or repeal legislation, but it has a big influence on what Congress does in these matters, and it is the chief banking regulator that implements and enforces regulations.)

Pros and Cons of Repealing Dodd-Frank

According to Steve McDonald’s recent Wealthy Retirement article, the repeal of Dodd-Frank could spell opportunity for investors...

M&T Bank alone saw its compliance costs increase from $90 million a year in 2010 to $440 million in 2016.

Capital requirements are one of the biggest drags on the performance of big banks. State Street Bank is required to have as much as 40% of its cash in risk-free Treasurys or the Federal Reserve. And the more cash it has tied up, the lower its performance.

The expected rollback in regulations would be a big boost for earnings across the board. Analysts are predicting a 30% earnings increase.

That said, eliminating Dodd-Frank could have a negative effect on investors who are unprepared... especially if history has anything to say about it.

Back in 2000, President Clinton and Congress passed the Commodity Futures Modernization Act (CFMA), a sweeping deregulation of swaps and derivatives. According to some economists, the CFMA made a significant contribution to the 2008 financial crisis.

The law loosened restrictions on the financial sector’s use of collateralized debt obligations and credit default swaps - the two instruments that were central to the collapse of the U.S. housing market.

As a result, many think the elimination of Dodd-Frank could have a similar effect.

Needless to say, this is something the Club is watching closely.

Until a decision is made concerning the future of Janet Yellen and the Dodd-Frank Act, stay the course. Stick to the Club’s Pillars of Wealth, and don’t get bogged down with the wrong questions.

But if you want to diversify your portfolio to adjust to the changing financial landscape, check out Fry’s Pinnacle Portfolio.

This service is run by Oxford Club Macro Strategist Eric Fry, and it contains an eclectic mix of international equities, commodities and options. It’s an excellent hedge against uncertainty in our financial markets. Click here to learn more.

Good investing,

Rachel

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