Summary

Trump administration moves to deregulate financial sector.

US financial sector is already bloated.

Further growth in the financial sector is likely to come at expense of growth in other sectors.

We’ve largely had a negative view of the financial sector since the crisis and have only owned one financial company very briefly many years ago. Yes, financials have pretty much always been cheap but interest rates were being kept low and the Obama administration (particularly the CFPB) was incrementally re-regulating the sector. Now we have a seismic shift in policy (or perhaps not seismic, depending on your view of just how much re-regulation the Obama administration actually did) in Washington.

Deregulation does not automatically mean we are going to have another financial crisis. Yes, it certainly increases the risk but astute investors can monitor both household and corporate debt levels for warning signs. What makes the financial sector attractive for investment is a function of how the sector works.

In a 2015 working paper from the Bank of International Settlements (the Central Bank’s Central Bank) by Cecchetti and Kharroubi presented follow-up research to a 2012 paper that showed after a certain point a growing financial sector had a negative effect on economic growth.

They found that once private sector debt passes 100% of GDP or the finance sector employs 3.9% of the workforce further growth of the financial sector has a negative effect on GDP growth. They posit that this is because “people who might have become scientists, who in another age dreamt of curing cancer or flying to Mars, today dream of becoming hedge fund managers.” It’s also because of the extractive nature of the finance sector. Making loans to innovative small businesses is great and helps the economy. Managing a fund of hedge funds and charging 1% of assets…