ANALYSIS-Even with new rules, life goes on for Wall Street

By Reuters Staff
June 27, 2010

By Steve Eder

NEW YORK, June 25 (Reuters) – U.S. lawmakers have hammered out a law that is designed to fundamentally change Wall Street, but financial professionals largely yawned.

Legislators took steps that at first blush could change the industry, including limiting banks’ swaps-dealing operations and their investments in private equity and hedge funds.

But in the end, banks like Goldman Sachs Group Inc, JPMorgan Chase & Co and Morgan Stanley won concessions that watered down the proposals that could have been most damaging to their profits, staving off a watershed overhaul like the one that took place after the Great Depression.

One former executive at a major bank estimated that profits for the biggest dealers could fall by 3 to 5 percent because of the bill, which is far better than some had expected.

“It really could have been worse,” one banking lobbyist said on Friday morning, calling the process “grueling” and saying that just 24 hours earlier the proposals were more damaging for banks.

“People are going to have to make changes and it is going to cost money, but it’s not going to ultimately change their ability to do business.”

BRACING FOR THE WORST

Banks were bracing for — and lobbying against — a proposal by Sen. Blanche Lincoln, a Democrat, to force them to spin off their swaps-dealing operations. They were also worried about the “Volcker rule,” the ban on banks’ trading first proposed by White House economic adviser Paul Volcker.

But in the end, lawmakers took much of the sting out of both proposals.

In fact, after lawmakers’ 21-hour final push to seal a deal, bank stocks opened higher, underscoring how the sweeping rewrite may not be the new dawn that financial giants feared.

Some of the most dramatic proposals, such as one that would have broken up the big banks, dropped out of the bill. What was left means pinched profits and a few new watchdogs for Wall Street, but largely keeps its business model intact.

Lawmakers built exceptions into the Lincoln proposal that allowed banks to continue to engage in foreign-exchange and interest-rate swaps dealing, which account for the bulk of the $615 trillion industry. Banks would also be allowed to continue to participate in gold and silver swaps and derivatives designed to hedge their own risk.

They would need to spin off dealing operations that handle agricultural, equity, energy, metal and uncleared credit default swaps.

The final Volcker rule was also diluted with a key exception that allowed banks to invest up to 3 percent of their Tier 1 capital in hedge and private equity funds.

That provision could still be significant for Goldman Sachs, which had $15.5 billion invested in its own funds, including private equity and hedge funds at the end of the first quarter. A securities filing showed the firm had committed to provide another $12.1 billion to these types of investments. The Wall Street firm’s Tier 1 capital was $68.5 billion at the end of the first quarter.

Under the new rule, Goldman’s investments are above the threshold, leaving the company to invest only about $2.1 billion in these types of portfolios.

WATERING DOWN

Analysts and consultants say the bill leaves room for a bank to establish a derivatives business inside its holding company, but to place it overseas, escaping U.S. regulations.

“To me, it really doesn’t matter much,” said Cornelius Hurley, a professor and director of Boston University’s Morin Center for Banking and Financial Law.

U.S. regulators have a history of being lax about enforcing the walls between different parts of a holding company anyway, he added. “It might make it more costly in the sense that there will be a compliance cost.”

The rewrite of the Volcker rule could allow major banks with large amounts of capital to continue to invest billions of dollars in hedge funds.

“I don’t see things in that bill structurally that are going to cause banks to have weaker earnings,” said analyst Richard Bove of Rochdale Securities.

With U.S. financial regulation nearing the finish line, international capital standards still are expected this year, which could add further rules for banking industry.

But for now, some question whether Congress has come up with regulations that will prevent another financial crisis.

While the Volcker and Lincoln rules will have ramifications for Wall Street, they still do not carry the might of Great Depression-era Glass-Steagall reforms, which barred banks from affiliating with securities firms and insurers. Those laws were largely repealed in 1999 — which amounted to another game changer in the financial rule book.

“When you look at the underlying causes of the crisis, this bill barely scratches the surface on those and in some ways it exacerbates them,” Bert Ely, founder of financial institutions and monetary policy consulting firm Ely & Co.

See also: FACTBOX – New regulations limit banks’ investments in hedge funds

(Additional reporting by Elinor Comlay; Editing by Lisa Von Ahn, Matthew Lewis and Bernard Orr) ((steve.eder@reuters.com; + 1 646 223 6069))

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