Global Market Commentary

Sparking Growth Without Congressional Action


After last year’s U.S. presidential elec-tion, small business optimism spiked at the fastest pace since the Reagan administration. Whatever the personal political views of American small busi-ness owners, they saw a silver lining in the election result: a likely turn from the previous administration’s regulatory strategy that could make their lives eas-ier. While the inflection in optimism has moderated, it’s still strong, in spite of the new administration’s outsider methods and sometimes confrontational style. Like everyone else, small business own-ers see the current difficulties in Con-gress and are reassessing their views of how quickly actual pro-growth legisla-tion can get passed. But as a group they still feel that better times are coming.


This optimism is important, because as we never tire of pointing out, small and new businesses are the work-horses of the U.S. economy, creating the bulk of new jobs and always incu-bating the next wave of technological innovations. The recovery of the U.S. economy from the Great Recession has been anemic compared to previ-ous recoveries in large part because the response to the crisis emphasized more stringent regulatory burdens across the economy. Such burdens hit small and new businesses especially hard, since they create new fixed costs that a bigger organization can absorb, but that can crush a smaller organiza-tion and make its operations unprof-itable.


Besides challenging the small-business engine of employment growth, regulatory burdens also sup-press one of the main components of overall eco-nomic growth: the improvement in workers’ pro-ductivity.


The graph on the following page shows that dur-ing periods when regulatory burdens are sharply increasing, productivity growth slows dramatically


  • and when burdens are decreasing, productivity growth accelerates.


Like everyone else, small business owners must be watching events unfold in Congress with concern. Yet they’re still hopeful.


What’s the reason for that hope? Part of it may be the perception of a global, synchronized uptick in economic growth. That uptick, it’s thought, pre-dated the election, and was based on global eco-nomic fundamentals that are largely independent of U.S. politics. In other words, positives are afoot, whether or not the new U.S. administration can make progress in a legislative agenda that supports them. Success in such an agenda would be icing on the cake. (We’re not sure that this view is wholly accurate, but it probably underlies some of the ongoing positive business sentiment.)

Something similar may be going on with small business-people’s hopes for a better regulatory environment in the U.S. The new administration’s ambitious legislative agenda is meeting a lot of resistance and struggle and is proceeding more slowly than many had hoped. Particularly, many business owners and market participants wanted to see progress on tax relief and were more con-cerned about this issue than they were about the repeal of the Affordable Care Act. They saw the prioritizing of Obamacare repeal as a partisan con-cern of some Congressional Republicans rather than a critical plank in the new administration’s pro-growth policies.

However, there’s hope because a lot of the administration’s pro-growth agenda doesn’t need to make its way through Congress. There’s a lot of scope for regulatory reforms within existing frameworks. In other words, regulators to some extent must operate within the substantial boundaries established by current regulations.


But within those regulatory frameworks, there are many constructive changes that can be made at regulators’ discretion, through interpreta-tion of rules, improved coordination among regulatory bodies, and so on. This kind of reg-ulatory improvement is immune to standoffs and struggles in Congress.

An Example: Community Banks and Finan-cial Regulatory Reform


Community banks play a special role in the U.S. economy. They’re “close to the ground,” and play a key role in lending to small businesses, since they know their markets more intimately than bigger institutions. Community banks make a quarter of all loans, but account for almost half of small busi-ness and commercial real estate loans, and more than two-thirds of agricultural loans.


They have had an extraordinarily difficult time since the crisis and the implementation of the sweeping Dodd-Frank financial regulation that was intended to rein in the excesses that led to that crisis. Overall, in the time since Dodd-Frank was passed, banks have been disappearing at the rate of one per business day. Startups of new banks have slowed to almost zero. Why? Simple — the median-sized bank in the U.S. has 42 employees. Adding the staff needed to com-ply with the huge expansion of regulations, and to constantly train them, is economically infeasible for many small banks. Seeing the writing on the wall, they have been folding and merging whenever the opportunity presented itself. Improving the reg-ulatory environment for community banks is critical, and it is one area where a lot of progress can be made without the need for contentious legislative efforts in Congress.


A month ago, the Department of the Treasury made its first response to an executive order that the new administration had made in February. That executive order outlined “core principles” of the administration regarding financial regulation:


  • Empower Americans to make independent financial decisions and informed choices in the marketplace, save for retirement, and build individual wealth;


  • Prevent taxpayer-funded bailouts;


  • Foster economic growth and vibrant finan-cial markets through more rigorous regulatory impact analysis that addresses systemic risk and market failures, such as moral hazard and infor-mation asymmetry;


  • Enable American companies to be competitive with foreign firms in domestic and foreign mar-kets;


  • Advance American interests in international financial regulatory negotiations and meetings;
  • Make regulation efficient, effective, and appro-priately tailored; and
  • Restore public accountability within Federal financial regulatory agencies and rationalize the Federal financial regulatory framework.


The order goes on to instruct the Secretary of the Treasury (Stephen Mnuchin) to “consult with the heads of the member agencies of the Finan-cial Stability Oversight Council and… report to the President… on the extent to which existing… government policies promote the Core Principles and what actions have been taken, and are cur-rently being taken, to promote and support the Core Principles. That report, and all subsequent reports, shall identify any laws, treaties, regulations, guidance, reporting and recordkeeping require-ments, and other Government policies that inhibit Federal regulation of the United States financial system in a manner consistent with the Core Prin-ciples.”


The Treasury Department’s first report covers bank regulations — later reports will cover other parts of the financial system, including capital mar-kets, the asset management and insurance indus-tries, and other non-bank financial institutions.


What is most significant and encouraging about the report is the extent to which it focuses on beneficial changes that can be made without the formal repeal of any aspects of Dodd-Frank.


The Harvard Law School commented:


“… the Report takes a less aggressive approach… Rather than advocating wholesale repeal of many Dodd-Frank Act post-crisis requirements (includ-ing the Volcker Rule), the Report focuses on recalibration and tailoring based on size, risk and cost/benefit analysis. This more modest and tailored approach may generate more support for the Report’s recommendations on both sides of the aisle. As expected, the Report also includes recommendations that could be implemented by Administration appoin-tees through interpretations or rules, with-out the need for legislation.”


Of 97 proposed regulatory changes, 62 require no action by Congress. These are focused on increasing the “tailoring” of rules so that when they are applied, they are applied in a manner sensitive to the institution being regulated. That’s especially good for mid-sized and commu-nity banks, which have been caught in a “one size fits all” straightjacket where their regulatory com-pliance costs have skyrocketed, even though they weren’t responsible for the irresponsible actions that helped precipitate the financial crisis.


Proposed changes also address the overlapping purview of multiple regulatory agencies, so that smaller institutions don’t have to cover the same ground with several different teams of regulators.


And the avowed purpose of the reforms, emphasized again and again in the report, is to boost economic growth by reducing com-pliance costs for mid-sized and community banks and thereby increasing the availability

of credit to small businesses.


In short, while the progress of the new administra-tion’s legislative agenda in Congress is uninspiring, there are practical efforts being made “under the radar” to make some basic, helpful changes to the regulatory environment in which some of Ameri-ca’s most important lenders operate.


Investment implications: The stocks of U.S. banks performed strongly immedi-ately after last year’s presidential elec-tion, but have lagged the broad market so far this year — largely amid fears that the new administration’s regulatory agenda would not make sufficient progress, and that interest-rate conditions would remain unfavorable. The longer-term story, though, is that intelligent work is being done “under the radar” to improve the regulatory environment for mid-sized and community banks — the latter being especially important support for the small businesses whose thriving is a key support for economic growth and job creation in the U.S. economy. The Department of the Treasury has identified many positive reg-ulatory reforms that can be accomplished within the current regulatory framework, without the need for contentious fights. We expect the Treasury to begin to roll these out immediately, and over the next two years, small and medium-sized banks will enjoy the benefits of these changes. To us, that supports an optimistic view on U.S. economic growth over the medium term.