New Regulations Guarantee a Market Thrashing

Dear John,

Here we go again!

Earlier this week, when I noted the market’s bad breadth suggests lower returns ahead, I mentioned that this is occurring at the same time regulations are getting rolled back.

Human nature is a funny thing.

It’s almost as if our behavior never changes, and we forget (or ignore) all the bad stuff that happened just a few years ago.

That’s why 100-year storms in the market happen every 10 years. Once it looks like we’re in the clear, we allow the same problems to punch us right in the face all over again.

In the meantime, we insist “this time it will be different.”

“This time” is never different.

Most of the regulatory rollback has been in the gutting of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
This was a key campaign promise that Donald Trump ran on during the presidential election.

Dodd-Frank was passed in 2010. It was aimed at limiting the damage from banks deemed “too big to fail.” It was also meant to protect consumers from having to bail those banks out again. There haven’t been any Lehman Brothers or Bear Stearns disasters since, so now must surely be the time to loosen up the rules, right?

Congress just voted to soften up the rules a bit to help out small and mid-sized banks. We’re talking banks with less than $250 billion in assets. They get a reprieve from rules they thought were expensive and onerous. These rules include stress tests, increased cash requirements, and more reporting, to name a few.

While most of the story has centered on Dodd-Frank, the devil’s is in the details.

The rollback of this legislation is just the first step in a broader effort to weaken the administrative state. It’s the next round of deregulation that could pose huge threats to our financial system.

The Federal Reserve is getting ready to ease up on rules that allow banks to use other people’s money – your money – to make huge, risky bets. That’s the real story. Not Dodd-Frank.

This type of trading works until it doesn’t. Then, the bankers walk away with millions of dollars, and Joe Sixpack gets caught holding the bag.

This is where the deregulation is headed next. It could do a doozy on the economy.

Banks have no business taking on massive leverage to make risky trades. The great investor Warren Buffett aptly calls these trades “financial weapons of mass destruction.”

There are plenty of rewards for traders when things go well, such as million-dollar bonuses, but few, if any, traders go to jail when they flush the financial system right down the toilet with risky bets.

We’ll end up right back where we started.

Actually, we’ll end up worse off in the end.

A major bank failure is practically assured. The market will implode with it. Trillions of dollars in bailouts will be given to folks that took excessive risk. It wasn’t fun the first time around, and it won’t be fun this time around.

Due to the massive Federal Reserve liquidity bubble created by low interest rates, the next bear market will be one for the history books.

Good luck out there,

John Del Vecchio

*Originally published in the Rich Investor