Reacting to Wells Fargo

by Roy C. Smith

 

On Sept 8, 2016, Wells Fargo announced that it had agreed to pay $185 million to settle charges of abusing customers through overly aggressive sales practices.

Two weeks later, Wells Fargo CEO John G. Stumpf was called before the Senate Banking Committee where he received a severe public dressing down from Sen. Elizabeth Warren. According to Sen. Warren, Mr. Stumpf should be “criminally prosecuted,” after, that is, he has resigned and given back his bonuses for failing “to be accountable” for his “gutless leadership.”

Apparently others in the Senate and elsewhere agree with her.  It’s an easy case to pile onto to express outrage against the banks, still America’s number one villains.

But, it is always hard for laymen like us to know enough about the facts in cases like this to form hard-edged judgments. Only the plaintiff’s side of the story has been told publicly, and the defendants are restricted in what they can or want to say. But, based on the reporting on the matter so far, Sen. Warren and the rest of us do know some things.

According to Mr. Stumpf, the bank discovered that some employees in local branches beginning in 2011 secretly opened new accounts for customers without their consent. This was an unexpected response by a considerable number of low-level branch employees to a poorly designed incentive plan to reward them for cross-selling the bank’s products for which there were quotas. This way of gaming the system spread throughout the branch network. As soon as the problem was discovered, the bank closed the unauthorized accounts, offered restitution to affected customers, and began to fire the branch personnel responsible (5,300 were fired over five years out of 100,000 branch employees, or an attrition rate of 1% a year).  Mr. Stumpf said the bank should have found out about the falsified accounts earlier, and addressed the issue more quickly than it did, but it acted in good faith once it discovered the problem.

In 2013 the Los Angeles Times reported on some of such accounts and a local lawyer began to accumulate a list of as many as 1,000 affected customers, presumably for a class action suit. The Los Angeles City Attorney read the story and began an investigation that ended with a civil lawsuit for damages. At this point the Office of the Comptroller of the Currency, a bank regulator, and the Consumer Financial Protection Bureau, (CFPB) a federal agency originally proposed by Sen. Warren and created by the Dodd-Frank Act in 2010, joined the suit as the heavy muscle. The CFPB ended up with $100 million of the $185 million (Los Angeles got $50 million).

By the time of the lawsuit, the bank was already engaged in trying to clean up the problem - responsible parties were fired, and Price Waterhouse was hired to investigate the issue independently from the bank’s own managers. Price Waterhouse found that perhaps 1.5 million unauthorized deposit and 500,000 unauthorized credit card accounts were created on which modest amounts of fees were charged. Over the five years in which the unauthorized activity occurred, fees on the deposit accounts amounted to $2.2 million ($1.50 per account), and $400,000 on the credit cards ($0.80 per account).  Against these fees, the bank paid incentive bonuses, and then had to pay the considerable cost of cleaning up. Last year Wells Fargo reported net income of $22.9 billion, so the amounts involved were not material to the bank’s shareholders.

Some observers have questioned the bank’s policy of creating ambitious quotas for cross-selling, that may have put excessive pressure on some low-pay employees causing the misconduct, though it does appear that the vast majority of branch employees responded to the quotas and incentives without breaking the rules.  Others point to failures in the accounting and control area that did not confirm new accounts with customers, or otherwise identify the problem early enough to keep it from spreading as widely within the bank as it did.  The bank and its board of directors has also been criticized for being slow and passive in pursuing responsible members of management and holding them accountable through clawbacks or other disciplinary measures.

It is clear that there were management mistakes and subsequent failures in the case. But, there is no evidence that management intended this to happen, or tried to cover it up once informed of the problem. By any standard other than Senator Warren’s, the damage done to customers did not constitute what she called a “massive fraud.”

Nevertheless, it certainly has turned out to be an expensive event for the bank, far more expensive than one might think initially.  Right after the announcement, Wells Fargo’s stock price dropped 5% while the stock price of bank’s principal competitor, JP Morgan, rose by 3%. That 8% difference amounts to $20 billion in lost market capitalization.

The market may have overreacted – the customer damages were small and further legal costs are unlikely to reach anywhere near $20 billion.  But, cumulatively the costs to Wells Fargo will be far greater than what they seem to be so far.

After the Senate hearings we learned that three US Attorneys from the Justice Department have opened criminal investigations, and the SEC is looking into civil infractions. The $185 million settlement did not involve the Justice Department – this is its first appearance on the scene.  For criminal charges to be brought against a corporation, the evidence must clear several difficult hurdles set by the Justice Department, but according to James Stewart in the New York Times, the facts in this case may be enough to do so.  Wells Fargo would have no choice but to settle any criminal charges, if made, even for a very large additional sum.  Banks cannot remain in business if convicted of felonies.

There is also the possibility of a class action on behalf of bank customers who were affected by lowered credit ratings and other difficulties as a result of the bogus accounts, and perhaps by employees who were fired for failing to meet quotas or for similar reasons. Such suits first would have to get by customer agreements requiring the use of arbitration for disputes, but sometimes they can. A guilty verdict in  federal case would invite and encourage class action litigation.

The event has surely caused some so far invisible reputation damage to the entity that before this event surfaced was America’s most admired, least sullied, and most valuable bank. In January, Wells Fargo traded at 1.7 times book value and had a market capitalization of $282 billion, in contrast to the much larger JP Morgan, that then, at 1.1 times book value, was worth $247 billion.

Even the generally supportive Wall Street Journal has suggested that Mr. Stumpf may be lucky to keep his job. Public pressure on the Wells Fargo board can only get worse. Threats of criminal investigations by the NY Attorney General of Citigroup and AIG in the early 2000s cost both of them their powerful CEOs at the time, Sandy Weill and Hank Greenberg, respectively. Losing Stumpf and or other top executives could be a further disruption to the bank.

Wells Fargo may argue that its policies and business practices over the years have been exemplary, and that customers have benefitted greatly from its products and cross-selling efforts, but in competitive businesses operated at large scale, mistakes will happen and when they do, the bank will remedy them. This is what we expect “good” corporations to do: to compete hard to get our business with good new products, but also to stand behind them and never try to cheat us. 

Wells Fargo probably believes that it has lived up to that standard for a long time, and is entitled to some benefit of the doubt when an embarrassing mistake is made. But one of the first signs of reputation damage is the loss of the benefit of the doubt.

Sorry, Wells Fargo, it doesn't work that way anymore.

In Remembrance of Lehman Brothers

In Remembrance of Lehman Brothers

Paul H. Tice

Guest Contributor

Lehman Brothers, the fourth largest U.S. investment bank, filed for bankruptcy protection on September 15, 2008 to send a message to the markets.  Eight years later, we are still struggling to decode the message and draw the proper lessons from that catastrophic event.

Much has been written and said about the bankruptcy of Lehman Brothers over the intervening years, including government inquiries, forensic reports and countless case studies. Yet for all this accumulated body of work, we still seem to be missing some of the basic take-away points.

The first Lehman lesson should be an obvious one: in the modern age of integrated global finance, the bankruptcy of a major investment bank can never be orderly, much less therapeutic for the markets.  Lehman Brothers still ranks as the largest U.S. corporate bankruptcy to date, with $613 billion of total liabilities reported when it filed Chapter 11.  When the firm collapsed, it touched off a global financial crisis, seized up credit markets worldwide and deepened an already-gathering U.S. recession. 

The Lehman bankruptcy estate is now readying its eleventh distribution of cash to creditors, with no end in sight for the process.  Along the way, there has been an incredible destruction of economic value across the financial sector, both in terms of spent time and legal costs.

And yet, under the Dodd-Frank Act, it will be the same game plan going forward, with any future failing financial firm to be resolved through an “orderly liquidation” process. 

While all systematically-important financial institutions must now have “living wills” in place, these confidential company directives are more placebo than panacea, and do not abrogate the need for regulatory support and consistency to maintain liquid and functioning financial markets during periods of stress.

Even with the proper paperwork on file, there is little reason to expect different results the next go-round, especially in a repeat scenario of 2008 when a series of major bank bankruptcies would need to be orchestrated in the midst of a systemic crisis caused by a market-specific trigger.

Second, while some have argued for the re-instatement of the Glass-Steagall Act, the housing of securities underwriting and trading activities in larger commercial banks actually represents a source of stability for the financial system, not the reverse.

Most of the industry players that disappeared along with Lehman in 2008 were stand-alone investment banks with smaller balance sheets that were more exposed to mark-to-market accounting, due to their large trading books and collateralized agreements.  When these investment banks ran into trouble, the solution was to simply merge them with their stronger commercial bank brethren, accelerating an industry consolidation that started back in the 1990s.  With or without public financial support, such government-facilitated combinations were preferable to the Lehman Chapter 11 alternative.

Third, it was not a lack of regulations on the books, but rather regulatory uncertainty and a lack of supervisory oversight, that contributed to the 2008 financial crisis, both before and after Lehman’s bankruptcy filing. 

Nonetheless, the Dodd-Frank Act, with its companion Volcker Rule, has mandated a total of 390 new rulemakings for the financial sector.  Of this target, 274 major rules or 70% had been finalized by July 2016, according to the latest progress report prepared by Davis Polk.  Six years into it, Dodd-Frank has added roughly $36 billion of regulatory costs and 74 million man-hours in paperwork filing for the industry, based on numbers compiled by the American Action Forum.

While some regulatory changes have been positive—notably, central clearing requirements for credit derivatives—Wall Street banks are now consumed with legal compliance, as opposed to financial innovation, market-making and providing liquidity for investors.  In many ways, what has happened to the financial sector post-crisis is similar to the regulatory takeover of the U.S. electricity sector during the 1930s, with banks now functioning as the equivalent of public utilities.  The key difference, though, is that finance is much more complicated than just keeping the lights on.

Lastly, the antidote for the weak corporate governance and poor risk management demonstrated by Lehman Brothers and many of its peers in the run-up to 2008 would include a series of simple prescriptions—such as less-compliant boards, more-proactive auditors and improved balance sheet transparency—rather than the wholesale elimination of all risk-taking.

Since 2008, Federal Reserve policy has distorted the pricing of all risk assets, as interest rates have been kept too low for too long, undermining fundamental trade conviction and positioning appetite and amplifying price movements. These days, even a 25 basis point increase in interest rates from a zero starting point is enough to paralyze the markets.  Now, every extreme volatility event in the markets is casually referred to as a “Lehman moment,” which shows how much memories have faded over the past eight years.

As the industry currently stands, the likelihood of a recurrence of the 2008 financial crisis is arguably very low, but at what cost?  The U.S. economy continues to generate sub-par growth, and few question whether a key contributing factor is a moribund financial sector cowed by compliance, averse to risk and struggling to retain talent due to artificially-suppressed compensation levels.  Given the stigma attached to a career in finance these days, it is not surprising that the number of finance majors coming out of business school has fallen off dramatically in recent years.

When Lehman Brothers collapsed, it also altered the course of an American presidential election, and changed the direction of this country.  Since then, Wall Street has been pitted against Main Street, and bi-partisan criticism of Wall Street banks has devolved into antipathy towards big business and wealthy Americans.  More recently, it has led to atavistic attacks on free trade and global markets and charges that the entire U.S. capitalist system is “rigged.”

All of which, at some level, can be traced back to the failure to deal with the bankruptcy of Lehman Brothers in a frank and open manner.  By not learning the proper lessons from Lehman and 2008, we remain stuck re-litigating the past, unable to move on. 

Something to think about as everyone pauses today to remember where they were eight years ago when the world’s financial markets stood still.

15 September 20167. Paul Tice is an Executive-in-Residence at New York University’s Stern School of Business and spent 14 years of his Wall Street career at Lehman Brothers.

What’s Next for Morgan Stanley?

By Brad Hintz and Roy C. Smith

ValueAct’s acquisition of a 2% stake in Morgan Stanley is the first, overdue appearance of an activist hedge fund on the global banking scene. What can it hope to accomplish?

ValueAct has a long history of being a “friendly” activist that studies troubled industry situations and seeks to “work with” management and boards to make useful improvements. In this case, ValueAct has expressed confidence in chief executive James Gorman and the management team and notes that at 70% of book value, its Morgan Stanley investment has been made at an attractive price no matter what happens.

But there has to be more to the ValueAct story than a simple value play. Morgan Stanley’s price to book valuation is low, but so is its return on equity. In 2015, the firm delivered an ROE of 6.5%, which was 7.9% less than its cost of equity capital. And in its most recent quarter, returns were still 6.8% below a reasonable equity return.

Indeed, since 2008 Morgan Stanley’s return on equity has averaged 7.1% below its cost of equity. This is because the company’s beta – an important factor in determining its cost of capital – has remained stubbornly high (>2.0) despite Gorman’s successful strategic transformation and de-risking of the firm’s business model.

Morgan Stanley acquired the Smith Barney retail brokerage business from Citigroup in 2010. Today, about half of Morgan Stanley’s revenue stream is from capital markets, and half is from wealth management and asset management. Its struggling fixed income unit has been triaged and its balance sheet trimmed. Morgan Stanley has maintained leading shares in M&A advisory and equity underwriting and increased its share of the institutional equity trading market. The separate Dean Witter, Morgan Stanley, and Smith Barney retail units have been integrated and margins in the wealth management business are now averaging more than 22%. The company’s capital ratios have been strengthened and management has stated that the firm is committed to returning capital through dividends (2.6% yield) and sizeable stock repurchases.

Altogether, Morgan Stanley has a good story. But, based on the high beta of its stock, the equity market appears skeptical. Or, put another way, the strategic changes have not been enough to deliver acceptable levels of profitability given the perception of risks associated with the capital markets business that the firm has retained.

The capital markets businesses of all the large banks have been struggling to deliver reasonable returns since 2009. Their continuing regulatory burdens and litigation challenges have led some investors to question their long-term economic viability. Morgan Stanley investors’ concerns focus mainly on the capital markets business, which is heavily dependent on trading units that require a massive balance sheet (roughly $800 billion of assets). Further, capital markets activities must squeeze through a new regulatory labyrinth of capital reserves, operating restrictions, and exceptional levels of oversight that constrain profits significantly.

ValueAct has not said what it hopes to accomplish with its investment, but a change in business mix seems likely. Morgan Stanley’s capital markets business consumes about 60% of the firm’s capital, and 35% of its revenues are from trading that drags down returns.

But capital markets require a mix of activities with different profit margins. Equity new issues and mergers and acquisitions advisory historically have generated high margins (approximately 40% pretax), but debt capital markets and institutional equity execution have generated relatively low margins (6% and 15% respectively). Fixed income sales and trading generate 18% to 20% pretax margins but require large capital levels to support market-making activities, and can be very volatile.

The low-hanging fruit for any activist investor is to slash or even shutter the highly capital intensive, low ROE trading units and return the capital to shareholders. Certainly if Morgan Stanley could grow its low risk and low capital intensity wealth and asset management units, while shrinking the capital-intensive businesses, ROE would improve.

Capital markets products and services are tied together through multiple client relationships across product lines. Institutional clients demand full-service offerings. Security issuers often demand medium-term note programs and low-margin debt capital market services as quid pro quo for the promise of high-margin engagements.

These inter-business connections make changing or exiting businesses such as institutional equities or fixed income trading a risky proposition for a major investment bank. This is especially true if the bank’s major competitors are firms like JP Morgan or Goldman Sachs that are not reducing capital market services.

Given these considerations, the most that ValueAct may be able to achieve is to “prune” the market-making business units hard. UBS has been successfully pursuing this strategy, thus freeing capital and reducing compensation expenses. Such a strategy at Morgan Stanley, if believed by investors, could reduce the beta of the firm and substantially reduce its cost of equity capital. This could allow Morgan’s net return on equity to recover to a much more viable positive number.

Indeed, ValueAct may see the real prize to be in de-risking the firm sufficiently to escape designation as a “systemically important financial institution” (SIFI), the real cause of the stresses on Morgan’s existing business model. (Lazard Frères, a leading M&A firm that is not a SIFI, trades at four times book value). The regulatory burden on SIFIs is very high and costly, and because of high capital thresholds and the unpredictable nature of stress tests, it has become very difficult for all SIFIs to establish a viable long-term business model within permitted areas of operations.

Avoiding this burden as a result of eliminating trading might recapture a great deal of market value, but, even though MetLife has successfully appealed against its SIFI designation, and GE Capital has had its repealed because it broke up the firm, there has been absolutely no indication that such a move would be acceptable to the Financial Stability Oversight Council or the Federal Reserve in the foreseeable future.

But we welcome ValueAct on to the scene. After eight years of underperformance, Morgan Stanley (and the rest of the industry) needs out-of-the-box thinking and external pressure to help accelerate and complete the transition of the firm from what it was before the crisis to what it needs to be in the future.

Published in eFinancial News, Aug. 24, 2016

More on the Net Regulatory Burden

by Roy C. Smith 

 

The Wall Street Journal today has an editorial entitled "The All-Time Regulation Record" quoting  a forthcoming report prepared by Sam Batkins of the American Action Forum, a right-of-center nonpartisan think-tank, that illustrates the continuing problem of net regulatory burden described in our post on July 5th ("Economic Growth and Regulatory Relief").

(See: http://www.wsj.com/articles/the-all-time-regulation-record-1470435716)

The Batkins report, based on data supplied by federal agencies, concludes that the Obama Administration has issued a record-setting 600 "major" rules since taking office, with perhaps 50 more to come. A major rule is one that imposes regulatory costs of more than $100 million.  Altogether, Mr. Batkins estimates these rules will cost up to $743 billion, or 4.2% of GDP, and will require nearly 200 million hours a year for compliance. Cumulatively, the WSJ estimates that this regulatory burden costs the US economy, now stuck in a seemingly endless low growth mode, about 1%-2% of its annual rate of growth.

Certainly some of this regulatory burden is beneficial and necessary. But certainly too, a lot of it is not. And as oblivious of the net regulatory burden as the Obama team may be, the trend towards excessive regulation did not start with it. The George W. Bush Administration provided nearly 500 major rules during its eight year term.  There is little evidence of rigorous cost-benefit analyses being applied to either of these teams' regulatory agenda. 

Yet voters in a crucial presidential election in November hear little of this. Both candidates have promised all kinds of things that would require considerable additions to the net regulatory burden if passed by Congress, and, if not, the candidates would seek to deliver them instead through executive orders.

We seem to be getting close to a point where Americans will have to choose between growth and regulation, but so far, few seem to recognize the trade-offs needed to get the balance right.

Leveraging the Great Consensus on Infrastructure

Ingo Walter

Amid the hurly-burly of this year’s US political conventions and the gravitational pull of left against right there is one issue the two leading presidential candidates and their surrogates seem to agree on, the need to invest in America’s infrastructure - usually preceded by adjectives like aging, decrepit, obsolete and uncompetitive.

They are right. Research suggests that infrastructure is a key determinant of growth by providing the sinews of the economy that make everything else more efficient – consumption, production, investment, trade and government activity. As a result, the social benefits of infrastructure investments tend to far exceed what their direct users end up paying for them, and these valuable spillovers help explain their outsize impact on economic performance and growth.

Both major candidates’ allegiance to the beleaguered “middle class” makes serious infrastructure investments doubly attractive. The benefits tend to be spread widely and not concentrated at the top of the wealth and income pyramid. They might even be called “progressive.” Greenfield and brownfield projects employ a lot of well-paid people across the skills spectrum – from architects and structural engineers to steelworkers and stonemasons - jobs that are impossible to outsource abroad. And the multiplier-effects across the rest of the economy, from housing construction to pickup trucks and sandwich lunches, are impressive.

So what could be better? Stimulating demand while creating the basis for greater near-term efficiency and long-term growth across the whole economy, all while creating income and welfare gains for the general population in a way that broadens income distribution. And all this at a time when the cost of capital is at an all-time low, inflation is a distant memory and there seems to be ample excess capacity in key sectors. Of course, there are a few problems.

Major infrastructure projects completed on time and on budget in China or France would be almost unthinkable in the United States today, where even the redevelopment of obsolete and sometimes dangerous infrastructure can involve years of public debate, regulatory approvals, environmental impact statements, litigation and other blockages. If infrastructure is as important as the candidates seem to think, a significant part of the US growth slowdown during the last decade could be attributed to all manner of special interests scrapping over slices of a stagnant pizza rather than pouring political and economic capital into baking a bigger pie and sharing the gains.

The 1956 Eisenhower Interstate Highway System was arguably the sole post-war “grand design” infrastructure project. American infrastructure development today seems largely decentralized and localized with federal “program” support, along with commercial projects undertaken in the private sector such as rail lines and electric power distribution. At the state and local level, in turn, the main stumbling block seems to be the long-term focus required for infrastructure and the short-term focus of the electoral cycle. Can the current political consensus among presidential contenders recreate the national will that made possible the transformative Interstate initiative?

And then there’s the financing. Infrastructure is uniquely vulnerable to the “free rider” problem. “Let the other guy pay. I’ll benefit anyway since it’s so hard to exclude my use, either gratis or at a price way below cost.” So what if another state or local infrastructure bond issue fails?

But there’s plenty of hope. Advanced technologies and “big data,” micro-metering that makes possible usage charges which can more accurately capture benefits and costs, and similar innovations are already being applied or are just over the horizon. Before you know it, corralling the free riders will make possible sustainable infrastructure finance in many sectors. And once this happens, the burden on public finance will ease and, in a yield-hungry environment infrastructure revenue bonds will become a darling of institutional investors like pension funds and insurance companies.

Whereas most infrastructure finance is executed in the public sector today, there is much to be said for the private sector, which already dominates oil pipelines, electric power generation, hospitals and the like. From airports to toll roads, from bridges and tunnels to ocean terminals, there is no reason, other than lack of political will, why world-class infrastructure cannot designed, constructed, operated and financed mainly in the private sector.

Available evidence suggests that stocks of infrastructure project sponsors in recent decades have outperformed other asset classes like real estate, with the added benefit of low correlations to the major indexes – therefore good portfolio diversification value. And bank lending (the mainstay of front-end financing for infrastructure projects) has bounced back nicely from the financial crisis, even as infrastructure bonds with investment-grade ratings show good potential for the future once the markets for these instruments mature.

Bottom line: Undecided or dismayed voters today can find cheer in something they usually don’t think much about. Infrastructure. It won’t get them out in the streets or standing on their seats doing fist-bumps. But it’s a rare “sweet spot.” If the candidates walk the talk and read their Eisenhower, there’s something going on here that will affect voters more than they realize.

Economic Growth and Regulatory Relief

by Roy C. Smith and Ingo Walter

Low rates of economic growth today seem to pervade the world economy. Few in China, Japan and emerging markets are happy with their economies’ performance. Politically, Brexit appeared to center on migration issues, but British voters have long chafed at the EU’s lack of economic growth and excess of regulatory micromanagement from Brussels. Many “leave” voters thought they’d be better off avoiding the stifling bureaucracy and simply playing by the rules of global trade as the US, China and other non-EU members do.

 But US growth has also fallen short, accounting for much of the skepticism and mistrust of the voting public. So far, the presidential campaign has been depressingly deficient in drawing-out the economic policy issues that will have a far bigger effect on American lives than almost anything else debated by the candidates.

Growth issues are crucial. Since 2000 U.S. GDP growth has averaged less than 2% per year, and seems to be stuck there for the foreseeable future. The average growth rate over the previous 50 years was about 3.5%. That difference, compounded over the years, is enormous. It is reflected in lower real per-capita income, private sector capital spending, renewal and new investment in infrastructure, productivity improvements, and other important roots of economic performance.

Meanwhile, the funds available to pay for federal, state and local pensions and the various social programs that most Americans expect their government to provide as “entitlements” are running out. Without faster growth they will require drastic changes. And the career prospects and the prosperity of future generations worry many American parents long accustomed to making progress from one generation to the next.

No wonder the voters are testy, and receptive to populist pitches to create major changes and start over.

Americans should be asking the candidates “Where’s the growth?” and “How are we going to get it back?” Without it, the U.S. will confront an economic future much like continental Europe and Japan. Standards of living may seem fine for the time being, but beneath the surface prosperity the prospective future wellbeing of the citizenry, the nation’s vitality and its global standing are gradually dissipating.

During the grueling primary season the surviving presidential candidates have invariably paid lip service to growth idling well below its potential, and the need to somehow hit the “reset” button. And yet there have been no coherent roadmaps for how this can be done.

Hillary Clinton and the Democrats, pushed hard to the left by Bernie Sanders and Elizabeth Warren, are focusing their campaign on re-slicing the economic pie by progressively alleviating “income inequality” through direct intervention such as trade protectionism, increasing the minimum wage, easing student-loan debt, tougher regulation of banks, and boosting taxes on hedge fund managers and others among the rich. The trouble is there’s no free lunch, and the policies tabled so far are more likely to shrink the pie than to enlarge it, and in the meantime, rival political factions will fight viciously over the shrinking slices.

One early presidential candidate, Jeb Bush, was alone in putting forward a plan to restore U.S. growth to a 4% level and jettison the “new normal” of 2% that has seemed to be acceptable to the Obama administration.  His plan included a major tax reforms, especially cuts for the middle class, to be paid for by eliminating some deductions and benefits provided to industry and wealthy individuals. The Bush plan was straight out of the old Republican playbook that has been in place since the Reagan era, but nevertheless had support from credible economists. The only plan on the table was cast aside along with Mr. Bush when the Trump juggernaut rolled over him.

Trump’s anti-trade economic plan – one that also offers major tax cuts but no changes in entitlement programs – has little credibility and omits the specifics needed for proper evaluation.  Republican voters will have to take it on faith that their party’s legacy economic policies will survive in a Trump presidency. But he has not signed on to these policies and up to now has proven to be  fundamentally unpredictable.

The basic Republican package – cut taxes to encourage consumption and investment - paying for it through borrowing if Congress fails to enact spending cuts – admittedly comes with a big increase in the federal budget deficit. That deficit, however, is now down to about 2.5% of GDP (compared to 10% in 2009), so there is some headroom in a one-off effort to kick-start the U.S. growth engine.

The Democratic plan differs mainly in where taxes should be cut and raised, with a “progressive” slant, making it more likely to boost the U.S. fiscal deficit over the longer term. Probably Congressional gridlock will prevent the Democrats from enacting their plans unless they can take control of the House of Representatives (possible, but not likely). Nor will Republicans be able to do much to enact their own programs without controlling sixty votes in the Senate (also possible, but not likely).

So it matters less what the candidates say they want to do than what they may actually be able do, mainly through their executive powers.

A president can wield significant economic power through regulation and  enforcement, and support and encouragement of the private sector (or not)   because federal regulation is now so pervasive and mostly relies on rules written by civil servants in the various administrative agencies.

Three recent studies shed some light on the cost of regulation in the U.S. A report by James Gattuso and Diane Katz of the Heritage Foundation (2016), found that in the first seven years of the Obama Administration new federal regulations reached a cumulative annual cost to the private sector of $108 billion, with the federal government spending additional $57 billion on enforcement. This represents “an unparalleled expansion of the regulatory state,” the authors claim.

            Another study by Bentley Coffey, Patrick McLaughlin and Pietro Peretto for the Mercatus Center at George Mason University (2013) estimated that the cumulative cost of U.S. regulation across 22 industries from 1977 to 2012 caused by “the distortion of investment choices that lead to innovation” amounted to an average annual reduction of the U.S. economic growth rate by 0.8%. The study concluded that if regulation had been held at constant levels since 1980, the U.S. economy by 2012 would have been 25% larger.

And a study by Mark Perry at The American Enterprise Institute (2013), concluded that the aggregate economic cost of regulation in the US since 1949 -- i.e., the total cost of compliance and reduced investment -- led to a 2% average annual reduction in U.S. GDP growth.

There are many other studies like this, including one cited recently by Speaker Paul Ryan, that point to the high residual drag on economic growth caused by regulation. Indeed, in 1993 the Clinton Administration established the National Partnership for Reinventing Government aimed specifically at cutting federal regulatory costs.

Of course, regulation can have value to individuals, businesses and American economy generally.  It protects the system against fraud, dangerous products, monopolies and various other forms of exploitation. It aims to make markets for goods and services fairer and more competitive.

Nevertheless, several studies including one by the Office of Management and Budget, note that the benefits of regulation have to be subtracted from their costs to obtain a meaningful idea of the “net regulatory burden” (NRB) imposed on the economy. The argument is that the NRB in the U.S. has grown to a level where it seriously damages growth and constrains the effectiveness of pro-growth policies regardless which political party is in power.

This “excess” regulation involves an economic burden through obsolete, ineffective, impractical, duplicative, market-distorting requirements that impact private-sector activities. NRB is certainly not entirely responsible for the drag on U.S. economic growth. But it is probably responsible for a good deal of it, and may be the most fixable in a new administration.

There seems to be a lot that can be pared-away. The Gattuso and Katz study points out that a great deal of new regulation (or stricter enforcement of existing rules) has been launched in the Obama years through the powers of federal agencies. Although some of these “executive authorities” have been challenged in court, few have been overturned.

Some of the principal launchers have been the Environmental Protection Agency, the Department of Transportation, the Department of Energy, the Anti-trust Division of the Department of Justice, the Federal Trade Commission, the Department of Health and Human Services, the Federal Communications Commission, the Financial Stability Oversight Council, the SEC, the CFTC, the FDIC, the Consumer Financial Protection Bureau, and the Department of Homeland Security.

Most of this new regulation appears to have been motivated politically and ideologically, and not subjected to Congressional approval or independent economic review. Canceling, simplifying and reducing the accumulated regulatory underbrush could release considerable economic energy to help restore growth, and is doable even with persistent Congressional dysfunction.

During its term in office, the Obama Administration also became increasingly unfriendly to business – it has blamed the financial crisis of 2008 on greedy businessmen and their Republican supporters instead of the more complex confluence of factors actually responsible. That attitude may have affected consumer confidence, fears of further layoffs and reduced appetite among businesses, particularly small ones, for investing for the future.

Obama’s regulation-inducing pessimism isn’t easy to explain politically, given that 85% of all working Americans are employed in the private sector. It would seem to make more sense for politicians to back an initiative that could instead unlock pro-growth potential.

It is possible that President Hillary Clinton would turn her back on the Obama regulatory policies, but at this point the likelihood of her championing a de-regulation turnaround seems low. President Trump - if properly advised and focused - might do so, but how such an effort under his control would turn out is impossible to predict.

In most presidential campaigns, the candidates move towards the center after gaining their nominations.  After all, in January 2016 a Gallup Poll reported that 42 percent of all voters are now self-declared independents (i.e., moderates) that do not respond to the extreme positions typical of primary campaigns in which only 17% of voters participated in 2016. Clinton, however, may not bother to shift towards the center if Trump continues to drop in the polls, more because of his extreme personality than his extreme positions.

Perhaps the best that can be said for Clinton’s presumptive economic policy directions is that, based on her pragmatic Clintonian family DNA (and her own wealth accumulated since Bill left office), she may at heart be a moderate Republican dressed up in Democrat clothing.

And the best that can be said for Trump is that, if elected, he will have revealed a powerful political majority that truly wants radical change in areas that affect the pocketbooks of average Americans. If that cohort is as large as Trump hopes it is, then he will have license to do radical things, whatever they might be. Some of these things, we assume, would be pro-business.

But if it turns out not to be large enough to elect Trump, then we are in Hillary’s hands. Will those hands be more Obaman than Clintonian?  Much of future growth hangs in the balance.