Wall Street's Varied Impacts

By Ben White
|  Wednesday, Jun 2, 2010  |  Updated 9:33 AM EDT
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Dems to Stake Mid-Terms on Wall Street Crackdown

Bonus season has arrived for Wall Street Execs.

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Democrats are planning to stake a big part of their midterm election pitch on “cracking down on Wall Street.”

But the truth behind the financial reform bill is this: Some parts of the industry are getting cracked down on a lot harder than others.

And some firms, in fact, may wind up getting off pretty light.

Wall Street banks such as Morgan Stanley and Goldman Sachs — already in the spotlight over a government fraud case — should avoid a body blow.

That’s because the provision most potentially damaging to these firms — the forced spinoff of lucrative derivatives trading desks — is almost universally expected to be dropped or dramatically watered down. And limits on trading may not go into effect for years.

But there’s plenty of pain to go around. Traditional banking giants — such as Citigroup, JPMorgan Chase, Bank of America and Wells Fargo — may take the biggest hit, said analysts, lobbyists and industry executives.

That’s because banks that focus on consumer lending and other “retail” activities are facing a big cut in fees they generate through the issuance of debit cards, according to analysts and industry officials.

And they could also face tougher scrutiny from a new consumer regulator and the threat of increased legal action by state attorneys general looking to file high-profile and politically beneficial cases on behalf of consumers.

The amount of money banks have spent lobbying over the past 16 months helps illustrate the current stakes. According to a review done for POLITICO by the Center for Public Integrity, JPMorganChase spent $7.7 million lobbying on financial reform and other issues over that time period, while Citigroup spent $6.8 million.

Goldman, by contrast, spent $4 million, and Morgan Stanley spent $3.7 million.

Of course, the relative overall size of the banks affects these numbers. And JPMorgan has a large and profitable investment bank and has actively fought Arkansas Democratic Sen. Blanche Lincoln’s tough derivatives language. But the numbers nonetheless help underline how big the impact of reform could be beyond what is typically referred to as “Wall Street.”

“If the Lincoln language somehow stays in, then yes, the Morgan Stanleys and Goldmans get hurt the most,” said Brad Hintz, a banking analyst at Sanford C. Bernstein & Co. and a onetime Lehman Bros. chief financial officer. “If you squeeze their [derivatives] trading, they don’t have another place to effectively deploy their capital.”

One X-factor in weighing the effect on individual firms is what happens to the “Volcker rule,” which limits the ability of banks to buy and sell investments with their own money — a practice known as “proprietary trading.” Just like individuals hope to fatten their bottom lines by playing the stock market, banks do it, too — and any limitations could affect their balance sheets.

But Hintz and others suggested that if the Lincoln language goes out, the impact on Wall Street could be much less damaging to revenue and profits, despite the likelihood of the Volcker rule being in the final bill.

“If the version of the Volcker rule we get is the version that came out of the Senate Banking Committee, it would be a presumed bright-line ban on proprietary trading. That sounds like a very scary concept,” said a senior financial services industry lobbyist who declined to be identified by name because of the sensitivity of ongoing negotiations.

“But then the definitions of what constitutes proprietary trading and the implementation of the rule would be left to regulators to work out after a period of study. That’s a lot of wiggle room,” he said.

This official noted that if the definition applies just to trading done exclusively with a bank’s own capital for its own account, that would only marginally cut into profits at Goldman and Morgan Stanley.

 

“If what is going to be banned is seven guys on a prop desk in London out there betting the bank’s money, or a little hedge fund inside the bank that gets banned, well, most of the Goldmans and Morgan Stanleys don’t do a hell of a lot of that anyway. [Goldman chief executive Lloyd] Blankfein himself put that at 10 percent of trading revenues at most, which is not that huge,” the official said.

And if even if a more stringent Volcker rule went into effect, Goldman and Morgan Stanley have an out: They could simply give up their bank holding company status and get out from under the restrictions.

The retail banks, however, are worried about a surprise amendment to the bill from Sen. Dick Durbin (D-Ill.) giving retailers more power over the fees they pay to banks and card issuers every time a customer uses a debit card for a purchase.

The so-called interchange fees generate about $40 billion in revenue every year for card-issuing banks. Banks easily beat back earlier efforts to regulate the fees, but Durbin’s language is viewed as likely to emerge in the final bill.

Banks could respond by bumping up fees in other areas, but they’ve already raised charges for overdrafts and other services far above historic norms, limiting their ability to push them up further.

An official at one large bank noted that it may be smaller regional banks that get hit harder by the interchange-fee provision. This person pointed to analyst reports suggesting banks such as Regions Financial, KeyCorp and SunTrust get a larger amount of revenue from debit cards than do national banks that are bigger players in credit cards, which are not covered in the exchange-fee amendment.

Then there is the matter of consumer protection. House Financial Services Committee Chairman Barney Frank (D-Mass.), backed by the Obama administration, has made it clear he prefers the free-standing consumer financial protection agency created in the House version of reform over the version in the Senate bill that would house the agency in the Fed.

And even the Senate version has its own budget and presidentially appointed head, ensuring it a significant level of independence. This regulator will have the power to oversee consumer products such as mortgages, credit cards, deposit-taking and many other activities typically associated with consumer banks.

This new regulator would impose new compliance costs on traditional banks as well as potentially limit profits on high-margin products such as risky credit cards and home loans.

“The fact is, the investment banks do not face the consumer regulator we do,” said one executive of a large retail bank. “They don’t face the swipe fee issue, and they don’t face 50 state regulators like we do.”

The Senate bill would allow state attorneys general to bring civil actions to enforce protections enacted by the new consumer agency. The Senate bill would also allow private parties to bring actions under federal or state law.

“This is going to be very tempting for politically ambitious attorneys general out there to go crusading for consumers,” one lobbyist said of the pre-emption language. “It also is going to be a huge win for the trial attorneys.”

Meanwhile, some other less noticed winners could emerge from the final legislation, notably exchanges that trade derivatives. Under any final scenario, most derivative trades will be forced into public forums rather than negotiating deals privately.

A recent analysis by Goldman Sachs suggested groups such as the CME Group (formerly known as the Chicago-Mercantile Exchange) could be big winners. “Regulatory reform remains uncertain and could change, but, incrementally, it is difficult to envision a scenario in which more transparency, more clearing and more electronic trading do not positively affect CME’s business,” the Goldman analysts wrote.

Large, less regulated financial institutions such as Blackstone, The Carlyle Group and KKR also could stand to benefit if Wall Street and commercial banks have to retreat from the hedge fund and private equity industries.

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