(Reuters) - For investors faced with an administration bent on cutting regulations, the obvious Trump play is to choose simplicity over complexity.
For the financial industry, of course, the obvious play is exactly the reverse.
That’s because regulation tends to minimize complexity in financial products, a complexity which is as toxic to the ultimate gains of individual investors as it is beneficial to financial services firms.
Trump has come out with all guns firing against what he sees as a heavy regulatory burden in the U.S., freezing implementation of all new and pending regulations as one of his first acts as president.
“We think we can cut regulations by 75 percent. Maybe more,” Trump said Monday in a meeting with corporate leaders.
My first reaction on hearing this: “I am never eating a sausage again.”
My second was that, to the extent this applies to financial services, a lot of investors are going to get hoodwinked. Or rather continue to be hoodwinked.
Much, as ever, is unclear when it comes to Trump policy: the extent to which he genuinely intends to cut regulations by 75 percent (or maybe more!); the likelihood that he actually could; and how much all of this would apply to the securities and savings businesses.
One new regulation which is likely to be de-fanged if not derailed is the Department of Labor’s fiduciary rule, which had been scheduled to take effect in April. Reports have said it may be the subject of an executive order as early as this week.
Already the target of more than one unsuccessful legal challenge from industry, the fiduciary rule would require financial advisors who give investment advice for retirement accounts, like Individual Retirement Accounts and 401k vehicles, to be subject to a fiduciary standard. A fiduciary standard, the single strongest such of its kind, means that advisors must act solely in the client’s best interest.
That’s a lot tighter, and allows for a lot less mis-selling and over-selling of expensive self-defeating financial products, than the alternative “suitability standard” which allows advisors considerable wriggle room to argue that heavy financial engineering or risk taking is in line with what the client is seeking.
The lower standard is a cash cow: the Obama administration estimated that conflicts of interest between advisors and clients left savers about $17 billion per year worse off, lowering annual returns by about 1 percentage point.
Given how woefully behind so many Americans are at saving for retirement and, further, how thin high returns may be on the ground over the next decade, axing the fiduciary rule would be a disaster.
One argument against regulation is that it impairs both innovation and efficiency, which is undoubtedly true sometimes, particularly in downstream technology industries where rules can stymie the adoption of better products.
In finance, though, based on 130 years of data, we have, almost literally, nothing to gain from innovation.
The unit cost of a dollar of financial intermediation has remained about two cents for 130 years, according to figures from Thomas Philippon, Professor of Finance at New York University. First the telegraph, then the telephone, then the mainframe computer and then the internet all came and yet, mysteriously, saving or allocating capital got not one whit cheaper.
Philippon argues that if savers are to benefit from the next wave of innovation, such as blockchain banking, it will be because regulation stops existing banks from co-opting it and keeping all of the benefits of efficiencies to themselves.
As for the costs of regulation when it comes to retirement savings you are going to have to demonstrate that they are greater than that 1 percent a year in returns that conflicts of interest are now costing clients.
Savers are actually in a comparatively better situation to defend themselves against the dog-eat-dog world of lower oversight and streamlined regulation which Trump seems bent on.
If food safety regulations degrade, most of us, unless we want to make our own sausage, will find ourselves at the mercy of industry. The same goes for the air we breathe, the water we drink and the roads on which we travel.
But while a great number of people would benefit from a financial advisor acting as a fiduciary, most retirement savers who don’t have access to one or don’t see the value will have low-complexity, low-cost options such as index funds. Combine that with diversification and regular rebalancing and most will do as well as they could reasonably expect.
Complex financial products are rarely made that way for consumers’ benefit and in the new world we are entering, savers should opt for the cheap and simple.
(This story corrects to Dept of Labor from Dept of Justice in 9th paragraph.)
Editing by James Dalgleish