What Does the Midterm Election Mean for Financials?

Speaker 1:
Welcome to TD Cowen Insights, a space that brings leading thinkers together to share insights and ideas shaping the world around us. Join us as we converse with the top minds who are influencing our global sectors.
Jaret Seiberg:
Welcome to Two Cents, the financials podcast at TD Cowen. I am Jaret Seiberg, Managing Director and Financial Services Policy Analyst at TD Cowen Washington Research Group. Today we're going to focus on the midterm election, which is coming up in just a few weeks. We expect the outcome to be a major driver of policy, not just through the end of the year, but in 2027 and 2028.
But first as always is my partner in podcast, Scott Smith, who is TD Cowen's specialty salesperson for financials. All right, Scott, what is the market saying in the run-up to earning season?
Scott Smith:
Well, Jaret, we had a pretty active conference season in the run-up to earning season. And overall, I think investors were left with the perception that things were fine in management commentary, but not really kind of incrementally constructive enough to bring new money into the space. And a combination of that and the fact that we had the Fed hike, and we've also had oil remain sustainably high and interest rates sort of running away a little bit to the upside, it really weighed on financials and fintech in particular.
But we've had some pretty material weakness. We've lost almost 8% in the BKX and closer to 10% in fintech. And regional banks have done a little bit better, helped a little bit by some expectation for bank M&A. And we've seen a little bit of that in the last couple of days. We do expect more. I know there's been a TD report to that effect, which has been getting quite a bit of traction.
But coming into earnings, we're similar to where we were coming into conference season. Everything seems fine. Credit seems fine. Maybe a tinge lower on the growth side, given where rates are, but remains to be seen how it's all going to play out and what companies are going to tell us about that two to three rate hike cycle and what that'll do to demand.
Jaret Seiberg:
All right, Scott, what about the capital market side of the business?
Scott Smith:
Well, Jaret, that's certainly one of the factors that had BKX underperforming regional banks. We've seen a little bit of limitations in demand for some of the capital markets activity. There've been a couple of more deals pulled as market uncertainty has spread a bit. And it has investors wondering whether or not we're going to be able to have as sustainable a view on capital markets activity when the banks report earnings in a couple of weeks.
Jaret Seiberg:
So, this is a little bit of an unusual earnings season because we're going to get through the first couple of weeks, and then we're going to have the next FOMC meeting on October 28th for the decision. How does that play into how investors think about earnings season?
Scott Smith:
Well, I'll be honest, it feels very much like investors have very fully priced in a series of hikes. And so, I don't know that there's going to be a whole lot that comes out between now and then that changes that unless there's something extraordinary in the macro data that changes that tone.
So I don't know that that really impacts the perception of how people are going to be trading through earnings. In fact, I think the bigger issue will probably be the re-emergence of AI as a front and center issue for financials. It kind of exploded back onto the floor a week or so ago when people really started paying attention to Muse AI and some of the things that that product can do.
So it feels like the Fed is largely priced in, but maybe the risk on the other issues, not so much.
Jaret Seiberg:
All right. And one last question for you, Scott. Just for those who are newer to paying attention to the space and newer to the podcast, can you talk a little bit about how earnings season works? Who typically goes first? How long does it last? What are the details here?
Scott Smith:
Well, unfortunately, if you include fintech and payments, it lasts an extraordinarily long period of time. But we generally kick off, in fact, always kick off with the very large banks in the lead along with BlackRock, which is also very early. So we get a pretty good view of the predominant amount of lending in the market, both on the commercial side, and on the retail and consumer side from those large banks. We get it very fast and very early.
And then we kind of roll into other banks which have regional focuses, which will vary a little bit, but we get a pretty quick and pretty early view straight away. And I do think we're going to have a generally constructive view there, but if there's a wild card in the bank piece alone, it's probably any emerging CRE risk from the rate hike.
Jaret Seiberg:
All right. Great, Scott. Thank you as always, it's going to be another fun month in financials. It'd be great to have you back here next month to talk about what we learned. All right, now let's get into our main segment, which is going to focus on the midterm election. I am sure by now if you are in a battleground state, you are afraid to turn on the television, whether it's over the air or cable, you are inundated with campaign ads.
The amount of cash being spent in certain swing states is truly extraordinary, whether that be the state of Maine where Susan Collins is seeking reelection as a Republican, whether that's in the state of Georgia where the Democrats are trying to keep the seat, or even in a state like Kansas or Texas, which traditionally have been solidly Republican, but where the Democrats feel they have a chance to gain two Senate seats.
Our House view here at TD Cowen is both the House and the Senate are going to flip to Democratic majorities. That view was a little bit more out there on a tree limb before the prediction market seemed to catch up to our perspective. And I would say that's probably the consensus view right now. The Republicans currently have a three-seat advantage in the House.
It is very difficult for us to see how the Republicans can retain that majority, even with some of the redistricting that occurred over the last 12 to 15 months. Not only did the Democrats counter some of that redistricting, but you also had a couple of efforts either stall or get blocked by the courts. As a result, it just seems that the Democrats have plenty of momentum to be able to gain a majority in the House.
It is really just a question as to how big that majority will be and the size of that majority will determine how much they can really get done. I do expect that Representative Maxine Waters, if the Democrats retake the House, will become the chair of the House Financial Services Committee. I realize that she is seen as a progressive fighter by many, but in our experience, Representative Waters is pragmatic and a deal maker.
You can just look at the number of bipartisan bills that she co-authored with House Financial Services Committee Chairman French Hill over the last two years to see that in action. And as a result, I do think that a Democratic controlled house can still be constructive on legislation. Her priority is housing. Her second priority is housing, and her third priority is housing.
And so I do think we will see the committee's focus, which for much of the last two years, despite the passage of the 21st century Road to Housing Act, has been on bank and financial deregulation. I think you will see a much bigger focus on housing legislation. Her top three priorities in the housing space are going to be down payment assistance for first time home buyers. It's going to be money to revitalize public housing to essentially take units and buildings that are uninhabitable or need major renovations, and turn them into available housing.
And then finally, for a workforce housing tax credit, basically a way to subsidize the creation and construction of houses that are going to be sold at or below the local median home price. The goal here is to provide smaller homes that average working families can afford to buy rather than some of the larger houses that home builders over the last several years have been preferring to construct. The reason the home builders have been looking bigger is because some of the fixed costs of building a house, you simply can spread those out over a larger purchase price with a bigger home.
The goal of the tax credit program would be to provide a way to offset those higher fixed costs, including zoning costs, local ordinances, building of roads and infrastructure to service the new houses. If you can offset those costs with this tax credit, the financial incentive to build smaller homes would be much greater.
Over on the Senate side, this is a much closer call. The Democrats must win four seats on net to retake the Senate majority. Three seats gets you a tie, but because Vice President Vance would be the tiebreaker that would keep the Senate under Republican control. Senator Fetterman is somebody to watch. He is a Democrat from Pennsylvania, though he spoke at the Republican midterm convention. He actually is more popular with Republicans in Pennsylvania than he is with Democrats. If he were to switch parties, which we do think is unlikely but not impossible, Democrats would need to pick up five.
There are now basically 11 competitive races. They are Alaska, Georgia, Iowa, Kansas, Ohio, Michigan, Minnesota, North Carolina, New Hampshire, Ohio, and Texas. That means that Democrats need to win eight of those to have the majority. I would certainly keep an eye on some of the unexpected states. Kansas is a great example of a state that we would not have expected to be in play, but it is certainly in play today.
And why is that and why are so many of these states now pick up opportunities for the Democrats? The reason for that is really comes down to the American voter. And what have we learned about American voters over the last several years? Well, they like cheap gas, they want cheap food, and they want cheap housing. And the problem for Republicans is that diesel prices are at record high and gasoline prices are not just above $4 a gallon, but in some areas over $5 a gallon. They want food to be inexpensive and yet ground beef is up 8% year over year, but even that understates it. Just the cost of going around the grocery aisle, it just feels more expensive. Survey after survey has consumers complaining about the cost of food.
And then we have housing, right? We just talked about how Maxine Waters is so focused on housing. Well, why is housing her first, second, and third priority? It's because average voters feel that housing is getting out of reach. And with the 30-year mortgage above 7% and a real possibility that it could be approaching seven and a quarter or even higher on election day, that's a real problem. Scott and I might be old enough to remember when getting an 8% mortgage was considered a great deal, but that's not what the public believes anymore.
The public believes that mortgage rates need to be below 5% or at worse starting with a five handle, to really be affordable. Mortgages above seven, it's just seen as too expensive, and it becomes a major barrier to expanding the home ownership rate, to newly formed families buying their own houses, to the traditional migration that we see as families start in the city. And then as their kids reach elementary school age, they move out to the suburbs. It's just hard for that cycle to persist when mortgage rates are this high.
The alternative could be a sharp decline in home prices, because that would be a way for monthly payments to end up as even. We can talk about some of the negative ramifications if we did have a sharp decline in home prices, I think certainly 2008 showed us the damage that can be done with a home price correction, but we're not expecting that despite the high rates. And the reason for that is the lack of supply.
If you don't have excess supply and you have people who really want to get in homes, it is just difficult to see corrections at the level that would really pose both a systemic risk as well as change the affordability equation for most voters. The difference now between where we were a couple of years ago on the housing affordability front is really one of geography.
In certain areas in the southeast and the southwest, where there is far less zoning and far more available land for building, we're actually seeing some oversupply of housing. We're seeing home prices moderate. So housing is simply not the big issue in some of those areas. The problem is that where we have a lot of competitive races, housing is a problem. Areas of the northeast, even states like Maine and New Hampshire where you think there might be plenty of land, we're even hearing in some of the urban areas in Texas concerns over housing. And so, given all these price issues, it helps explain why the Senate is in play and why the conventional wisdom is kind of caught up to our view that Democrats have a real shot at winding up with control.
All right, so what happens if the Democrats do take control of the Senate? Well, now things get really interesting, because Sherrod Brown probably has to win in Ohio for the Democrats to take control of the Senate. Sherrod Brown, we believe, has been promised the restoration of his seniority. That would mean he could be first in line to be chairman of the banking committee. I think he does not seek out that job, and I think he is more likely to try to assert his seniority to become chairman of the Senate Agriculture Committee.
If that happens, it likely means that Senator Elizabeth Warren will be chairman of the banking committee. Now, that'll be a lot of fun for policy wonks like myself. Elizabeth Warren is certainly the most outspoken senator on the Democratic side when it comes to financial issues. Her fame came from the financial crisis. The Consumer Financial Protection Bureau was her brainchild and she helped stand it up, and helped pick the first director of it. She has been a vocal critic of some of the efforts at bank deregulation. She has been a vocal critic of bank M&A, not a fan of consolidation.
So what is that going to mean on the policy front? Well, it means that our bank regulators are going to have a lot of uncomfortable hearings before the Senate Banking Committee. She is going to use the power of the gavel to bring them up to ask lots of questions, but the reality is that there's very little that Congress can do when it comes to banking policy, absent passing legislation. And there's no scenario in which the Democrats are going to have the 60 votes needed to do major re-regulation of the financial services space.
It's why I do think Trump's regulators will continue on the deregulatory path. It's why I think deregulation will remain a tailwind for financial companies well into the 2028 presidential campaign cycle. And it's why I expect the environment for bank M&A to be quite positive for much of 2027. I think companies that want to do deals would be smart to announce them by the end of Q1 '27 just to avoid the 2028 presidential election cycle completely. But conversely, you probably have until the end of Q3 2027 if you want to be sure that these regulators are going to be the one that review and approve the transaction.
The other big thing to watch from this election if the Democrats do sweep the House and the Senate is what it means for crypto policy. I expect on the crypto front, the focus is going to be on investigating World Liberty Financial and the other crypto entanglements around the president and his family. I think Democrats believe that there's a lot of certainly uncomfortable dealings there that they want to put into the public light, especially before the 2028 presidential election.
And so, I do think we are going to shift from how do we pass the Clarity Act on crypto market structure, and we're going to focus much, much more on the president's current crypto dealings, the interconnectedness of crypto companies, how money laundering and know your customer and terrorist financing protections apply in the crypto space, and how are we going to tax crypto transactions? So I think that is something that is going to be a major area of focus.
On the housing front in the Senate, Elizabeth Warren certainly shares many of Maxine Waters' concerns and priorities on the housing front. I do think it will be challenging to get a major housing bill with bipartisan support both through the Senate and past President Trump, but certainly it's not impossible. It's really on whether the President wants to embrace working with a Democratic Congress, much like Bill Clinton embraced working with a Republican Congress during his final two years, or is this just going to be a period of prolonged conflict? Certainly, I think the latter is more likely, but I want to be an eternal optimist, so we will be hoping for the former.
So that pretty much wraps up our pre-election preview here and what it means when we are back in front of everybody in just a month or so after the election. We will go through the results and have a lot more color. All right, so now let's switch to our final topic for this podcast, which is to recap what's happened over the last month or so, and then look forward to what we're expecting in October and beyond. We certainly had an interesting several weeks on the financial policy front. Policy really was dominated by crypto with the Clarity Act in the Senate.
At the end of the day, they could not get 60 votes needed to start debate on the Clarity Act in the Senate. And as a result, the bill has stalled. For those not familiar with the Clarity Act, it is the crypto market structure legislation. It was a top priority for the crypto industry. The banks have been fighting the bill because of a dispute over yield on stable coins. What the death of the bill means is that we will be turning to the regulatory agencies to provide a lot of the policy certainty that we were hoping to get from Congress.
The SEC has already moved forward with a big proposal on how to tokenize securities. Most notably there is the requirement that the issuer approve the tokenization. We're expecting a big proposal out of the CFTC. They have given notice to the Office of Management and Budget that the plan is on its way. And then we have the banking agencies which have a lot of control over stable coin issuance under the GENIUS Act, which Congress passed earlier in the session. The key to Watts there is the OCC effort to tackle and limit stablecoin yield through regulation. I expect that's going to be a big area of battle, and one where we're going to get commentary from Capitol Hill as well as from industry.
In terms of what we're looking forward to over the next month or so, both the House and the Senate effectively are on recess through the election, and so we will not have a lot of the testimonies that we normally get in the fall. That includes from the banking regulators. The House hearing with them had been canceled, and the Senate hearing is clearly not going to occur because they are on recess.
We do have oral arguments in the Sixth Circuit on a challenge to debit interchange. This matters to the card issuing banks as well as to Visa and MasterCard. We have the FOMC decision on October 28th. We also are looking for that CFTC crypto policy proposal that I was discussing a few minutes ago. The midterm elections come up on November 3rd, and then we're going to get into, I think, a pretty busy period where we're going to look for the Senate to confirm Brian Johnson as the CFPB director.
We should get a Fed proposal on adjusting supervisory thresholds, that matters to regional banks. We're looking for the Federal Reserve in December to finalize the Basel III endgame reforms on the capital side, also a big deal to regional and large banks. And we have a liquidity proposal coming out of the banking agencies that could be really helpful to larger banks by allowing them to count discount window capacity towards a number of their liquidity requirements. In short, it is going to be a marathon to get through the next couple of months.
The agencies have a lot in store and a lot they want to get done, so we will certainly have a lot to talk about when we reconvene for the November podcast. So with that, I am going to wrap up here with the October edition of the TD Cowen Two Cents Podcast. Thank you as always to Scott for being our guest this month. I am Jaret Seiberg with TD Cowen, and I look forward to having everyone tune in next month for our financial policy podcast.
Speaker 1:
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