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Former Treasury Official: 3 Reasons to Avoid Financial Stocks

Former Treasury Official: 3 Reasons to Avoid Financial Stocks


By    |   Tuesday, 07 February 2017 11:38 AM

Stocks of financial services companies have jumped since Election Day, when Donald Trump triumphed on a campaign to reignite the U.S. economy, partly by rolling back regulations on banks and insurers.

Investors who want to chase the rally may want to consider the advice of a former U.S. Treasury official who sees 3 reasons to avoid financial stocks.

“With the potential dismantling of Dodd-Frank, some of these stocks look quite attractive going forward,” Kevin T. Jacques, a professor who used to work as an economist at the treasury, said in a Seeking Alpha post. “But to be honest I don't own any bank or financial stocks in my portfolio and likely never will.”

President Barack Obama in 2010 signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act as a response to the 2008 financial crisis that led to taxpayer-funded bailouts of banks and insurance companies. President Trump has criticized the law for limiting the ability of small businesses to get financing from banks.

After Trump won the election on November 8, the Financial Select Sector SPDR exchange-traded fund that tracks the industry rose more than 19 percent. Goldman Sachs Group Inc. surged as much as 36 percent, helping to push the Dow Jones Industrial Average to record highs, as investors looked forward to an era of fewer restrictions.

“Even without changes to Dodd-Frank, the risk to bank stocks is likely underestimated by investors,” Jacques said. “And while there are certainly significant benefits to be achieved by dismantling selected parts of Dodd-Frank, if politicians don't do it carefully and with foresight toward the safety and soundness of the U.S. financial system, then it may significantly increase the risk to our financial institutions and their shareholders.”

Jacques has three reasons to avoid bank stocks:

Another Financial Crisis: Predicting when an asset bubble will deflate, which the Federal Reserve failed to do before the dot-com bust and the subprime housing crash, or when banks will collapse is almost impossible. It’s like trying to predict human behavior.

“Financial regulators can regulate or monitor all kinds of risk in the financial system: market risk, credit risk, interest rate risk, etc. But what they can't regulate is the human factor whether that be fear or greed or hubris or arrogance,” Jacques said. “That makes predicting future financial crises (and ultimately the stocks of financial institutions) tenuous at best.”

Faulty Risk Measurement: “Despite all the advances in computer technology and big data, financial institutions still have trouble measuring risk,” Jacques said. “Risk models are generally built to assess risk under normal market conditions. But financial markets are subject to wild, unpredictable swings.”

Unintended Consequences: “Part of the reason unintended consequences occur is because regulators often build one-size-fits-all rules for financial institutions,” Jacques said. “Part of it occurs because regulators don't have perfect knowledge of how financial markets and institutions will respond to changes in regulation.”

He points to the subprime mortgage crisis as the unintended outcome of decades of U.S. housing policy that encouraged homeownership, but also allowed for a profusion of loans to people with little or no ability to make their monthly payments. 

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Stocks of financial services companies have jumped since Election Day, when Donald Trump triumphed on a campaign platform that included promises to roll back regulations on banks and insurers.
financial services, banks, stocks, investing
Tuesday, 07 February 2017 11:38 AM
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