Whew! That was close! After 18 months of threats, saber rattling, and posturing about the demise of the competitiveness of the American banking system, we finally have a financial reform bill, although it has more holes than a hunk of Swiss cheese. There is no return of Glass-Steagall, no breakup of the big banks. Crucial definitions, like one for “proprietary trading”, got lost in the Bermuda Triangle.
An industry that was sweating bullets poured tens of millions of dollars into lobbying efforts to render this bill toothless, $6.7 million from JP Morgan (JPM) and $5.5 million from Citicorp (C) alone, and they certainly got their money’s worth. Hedge funds nearly got off Scot free, merely getting stuck with a fraction of the $20 billion tab for regulation if they manage over $10 billion. As I write this, teams of lawyers are burning the midnight oil, creating subsidiaries and special purpose vehicles to sidestep the most onerous aspects of the 1900 page opus, which we are assured, no one has read in its entirety.
But there is no kidding yourself that the banking business hasn’t fundamentally changed. The days of taking insanely leveraged risks with a government financed safety net are clearly over. The adoption of the gist of the Volker Rule will limit proprietary trading, but it never was a good idea to let kids play with matches anyway. These guys were way out of their depth the day they started pretending to be hedge funds. The hugely profitable OTC derivative issuance business is migrating to listed exchanges where it belongs, like the CBOE (click here for my piece at http://www.madhedgefundtrader.com/june-22-2010.html ).
Unfortunately for the rest of us, the new restrictions on credit amount to a de facto quantitative tightening that will shave a few dozen basis points off of our long term GDP growth. Banks will see some of their most profitable businesses disappear, while getting loaded up with a boatload of costly, new regulation.
Now that the umbrella is no longer needed, you can expect Goldman Sachs (GS) and Morgan Stanley (MS) to bid adieu to their banking licenses and revert to investment banks, private equity firms, or even hedge funds.
The bottom line for those left is that they are allowed to stick around, but only with clipped wings as lower earning, higher cost operations deserving of shrunken multiples. Pass on the financial ETF (XLF). Toss all this in with the unknown amounts of toxic waste that still lurk on bank balance sheets, and I want to avoid the sector like a blind date who shows up with bleeding sores on her face.
To see the data, charts, and graphs that support this research piece, as well as more iconoclastic and out-of-consensus analysis, please visit me at www.madhedgefundtrader.com . There, you will find the conventional wisdom mercilessly flailed and tortured daily, and my last two and a half years of research reports available for free. You can also listen to me on Hedge Fund Radio by clicking on “This Week on Hedge Fund Radio” in the upper right corner of my home page.