Wall Street Reform Singes, Not Burns

The doomsday scenarios are most likely exagerations

By Ben White
|  Monday, Jun 21, 2010  |  Updated 9:30 AM EDT
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Wall Street Reform Singes, Not Burns

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People pose for pictures beside the Wall Street bull.

If you listen to Wall Street, the next several days will decide whether Washington destroys its business model and unleashes fresh chaos on a financial system already struggling against a recent global meltdown and punishing recession. 

New York lawmakers say the changes could cripple an industry that’s the state’s lifeblood.

The truth, however, is far less dramatic, no matter how the remaining financial reform fight plays out, analysts said.

Will there be pain? Certainly. Two of the banks’ biggest moneymakers — making big market bets with their own money and selling complex derivatives — would be curbed or eliminated if reform winds up where it appears headed.

But the bottom line: Financial giants that once minted money will mint somewhat less — anywhere from 10 percent to 20 percent less — according to new reports that try to predict the reform bill’s impact. No banks will close their doors. Giant bonuses that sparked public outrage will quite likely come down but perhaps only to somewhat less eye-popping figures.

Not only that, industry insiders are still hoping that House and Senate negotiators will find a way to water down the restrictions on banks trading with their own money, the so-called Volcker rule. Bank executives and lobbyists pushed hard through the weekend to further lessen the blow from the legislation, including by seeking assurances that banks will not have to sell off private equity and hedge funds, as long as they consist entirely of outside investor money.

“There are a lot of things we don’t like here. And there a lot things we think are just very bad policy ideas,” said one financial lobbyist, who, like several others interviewed for this story, declined to be identified by name because of the highly sensitive nature of final negotiations on the legislation.

“But for most people, it’s not necessarily going to be a massive hit. And it will most likely be phased in over two years,” the lobbyist said, noting that this would give the market time to get used to somewhat lower earnings potential at U.S. banks.

In the worst-case scenario for Wall Street, banks that are more reliant on trading revenue — such as Goldman Sachs and Morgan Stanley — could see their profitability dented by about 20 percent, analysts said.

Full-service banks that play in the markets while also serving mom-and-pop clients — a group led by JPMorgan Chase and Bank of America — could see their profitability drop by as much as 15 percent. Overall, the industry would probably see profits decline by about 10 percent.

The analysts found that a tough version of the Volcker rule would cost JPMorgan Chase, Morgan Stanley and Bank of America anywhere between $1 billion and $2 billion, analysts predicted.

That’s no small amount of money, of course — though JPMorgan Chase brought in $106.8 billion last year, with a net profit of $11.7 billion. Morgan Stanley’s revenues were $23.4 billion, with a profit of $1.1 billion.

One firm that could take a serious hit from the Volcker rule: Goldman Sachs, which could lose $5.6 billion in annual revenue, according to a Citigroup analysis. Goldman had revenue of $45.17 billion last year and $13.39 billion in net profit. The losses for all the firms could be pared back if conference committee negotiators agreed to lessen the blow from the Volcker rule.

And there could be job losses: The derivatives provision and a strict Volcker rule would almost certainly cause banks to eliminate high-paying trading and support positions. But some of those people are already finding work elsewhere, as hedge funds and private equity groups have begun hiring them away from the in advance of financial reform passage.

Democratic leaders on the financial reform conference committee, along with Treasury and White House officials, spent part of the weekend preparing for what they hope will be the final days of debate over the sweeping financial overhaul bill.

Wall Street banks and some Republicans said that because of the contentious nature of the remaining issues, final passage is not likely before the July 4 break.

Either way, the endgame is at hand. And despite pushback from moderate Democrats and members of the New York delegation, the final bill seems likely to lean strongly to the left.

Neither of the conference committee’s two leaders — House Financial Services Committee Chairman Barney Frank (D-Mass.) and Senate Banking Committee Chairman Chris Dodd (D-Conn.) — has given any indication that he plans to drop Arkansas Democratic Sen. Blanche Lincoln’s tough language on derivatives from the bill, despite continued opposition from Treasury, the Federal Reserve, the Federal Deposit Insurance Corp. and other regulators.

Financial lobbyists and executives said opposition from the New Democrat Coalition, New York-area politicians and regional banks could give some political cover to kill the provision while beefing up the Volcker rule’s ban on proprietary trading.

Should Lincoln’s provision stay in, analysts said, the biggest impact would be on major derivatives players, including Goldman Sachs, Morgan Stanley and JPMorgan Chase, with reforms shaving perhaps 2 percent off earnings.

Wall Street is also worried that conferees will settle on a tougher version of the Volcker rule ban on proprietary trading, named for former Federal Reserve Chairman Paul Volcker.

The language passed by the Senate would allow for a period of study to define what constitutes proprietary trading. But language originally drafted by Sens. Jeff Merkley (D-Ore.) and Carl Levin (D-Mich.) — but never voted on in the Senate — would eliminate the study period and immediately ban all non-customer-related trading.

Here are some of the other major points of contention this week:

— An amendment from Sen. Susan Collins (R-Maine) to tighten capital standards for banks — the amount of cash and other assets banks keep on hand to do business. Collins wants to set minimum levels and eliminate certain classes of instruments from counting toward the total.

Banks argue that Collins’s amendment could put U.S. firms at a competitive disadvantage while impeding global capital flows. Treasury has expressed opposition to her proposal.

However, the Maine senator was one of just four Republicans to support final passage in the Senate and thus is vital to the bill’s chances, making it difficult to kill her provision. “I just don’t see how you get it out,” said one official at a large Wall Street bank.

— Whether to assess some kind of fee on banks to generate $20 billion in revenue to help cover the cost of implementing the reform bill.

— The issue of a pre-funded liquidation account to help pay for winding down failing banks. The Senate rejected the idea of a fee on banks to pay for a $150 billion liquidation fund, but House Speaker Nancy Pelosi (D-Calif.) supports it.

— Debit card “swipe fees.” An amendment from Sen. Dick Durbin (D-Ill.) would allow the Federal Reserve to determine “reasonable and proportional” fees charged to retailers when customers pay for purchases with debit cards.

Heavy lobbying by smaller banks, credit unions and some state government officials, who argue that the measure would affect the payment of welfare benefits through debit cards, could end up easing the impact of the Durbin provision. And under any scenario, the measure is not expected to cut bank earnings by more than about 1 percent.

No matter how the financial reform bill finally shakes out, the banking industry may get something of a boost from an end to the long-running reform fight.

Shares in financial firms have taken a big hit since debate over the bill began in earnest in the Senate earlier this spring.

Shares in Goldman Sachs — admittedly hit by other issues such as civil and criminal investigations — are down about 25 percent since April 15. JPMorgan Chase is down about 18 percent over the same period. Much of the drop stems from investors factoring in the worst possible outcomes from financial reform.

So President Barack Obama’s signature on Wall Street reform could stop the bleeding, at least until the inevitable fight over implementation of the new rules begins.

“We expect final clarity of rules in the days immediately preceding the president’s signature of the bill to provide a positive tail wind” for banks, Citigroup analysts wrote.

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