Fisher Investments Editorial Staff
US Economy, Politics

The Paper Companies’ Big Win

By, 06/28/2010

Story Highlights:

  •  Following a marathon session, Congress successfully reconciled differences between the House and Senate versions of financial industry regulatory reform Friday.
  • Much is contained in the 2,000-page bill—but conspicuously absent are reforms targeting the principal drivers of 2008's financial crisis.
  •  While the resulting bill has no significant negative effects for banks and the broader economy, it also lacks real regulatory improvements.
  • Greater clarity provided by the bill is a plus for stocks, removing uncertainty surrounding potential industry reform.


At dawn Friday morning, US politicians emerged from a 20-hour session reconciling differences between House and Senate versions of a financial industry regulatory reform bill. The big winners? Paper companies! The resulting bill is fully 2,000 pages long. (Politicians seem fond of bills twice as long as Tolstoy's War and Peace lately.) It's the culmination of politicians' palpable desire to take some action—misguided or not—to address the financial crisis that's already passed. In our view, four reams later, it still doesn't touch the root causes of volatility and credit tightening in 2008. (Then again, we didn't expect it to. "Reform" is usually reactionary in nature and usually wide of the mark.)

So what's proposed in this tome? Here are a few of the highlights (or, in many cases, lowlights):

  • A defanged version of the much-ballyhooed Volcker Rule will limit banks' investment in private equity and hedge funds to 3% of Tier 1 capital and 3% of the fund's assets. Proprietary trading rules were deferred to regulators.
  •  Large hedge and private equity funds must register with the SEC and will be inspected.
  • Banks can hold investment grade derivatives on their books, but those below investment grade have to be spun off into a separate subsidiary. (Who decides what's investment grade? That's right—the credit rating agencies.) Many standardized derivatives will be moved onto exchanges. Custom derivatives can still be traded off exchanges, but will need to be reported to a central repository to gain transparency.
  • CDO underwriters cannot participate in either side of the CDO created. (They're looking at you, Goldman Sachs.)
  •  Mortgage writers must retain a 5% stake in loans, even if securitized.
  • Verification of a borrower's income, credit, and job status will be nationally required for mortgage lenders.
  • The SEC will be permitted (not required) to hold brokers to a fiduciary standard similar to investment advisors.
  • Debit and credit card swipe fees received new limitations.
  • A consumer protection bureau will be created within the Federal Reserve.
  • The Financial Stability Oversight Council—a so called "super-regulator" (consisting of various existing regulators) created to monitor Wall Street's largest firms.
  • The FDIC, already able to liquidate failed firms, would be chartered with unwinding large failing firms.
  • The temporarily increased FDIC insurance threshold of $250,000 would be permanent.
  • A one-time fee, levied on banks with greater than $50 billion in assets and hedge funds with greater than $10 billion, will be collected over five years creating a $19 billion fund to pay for all this reform.

Some principles laid out in the bill are decent ideas (for example, greater derivative transparency and making FDIC insurance increases permanent), but important potential improvements are absent. As former FDIC Chairman William Isaac put it, "The bill clearly would not have prevented the crisis of 2008."

The implementation of disastrous regulatory and accounting rule changes like FAS 157, remain unaddressed. Instead of consolidating regulatory authorities to obtain better coordination, proposed are two new regulatory acronyms. Credit rating agencies received no real reform of their special oligopoly—in fact, their position was marginally strengthened. And Fannie Mae and Freddie Mac escaped relatively unscathed. Still, political proponents seem pleased with the result. Senator Chris Dodd was even brought to tears, saying, "We believe we've done something that has been needed for a long time. It took a crisis to bring us to the point where we could actually get this job done." (We wonder just how long. Maybe 10 years? Because that's how long ago Senator Dodd and his brethren voted for Gramm-Leach-Bliley, which the watered-down Volcker Rule now aims to undo.)

Greater clarity afforded by the bill is a plus for stocks—highlighted by an up day for US stocks Friday, with Financials outperforming. As off-target as many of the proposals are, none seem so onerous as to pose major economic or market risks. Some aspects may weigh on bank earnings, increase costs for bank customers (aka everyone), and make less credit available than there would be otherwise. But that's largely offset by the fact banks today are exceptionally well capitalized, interest rates are extremely low, and yield curves are steep globally—a solid environment for bank profitability. And with the uncertainty surrounding the bill out of the way, banks might be more willing to lend the near record reserves now parked at the Fed. On balance, the bill appears to be a lesser version of what was originally proposed, with a nebulous outcome at best. More tweaks are likely along the way, but with some certainty about the future financial landscape, investors have one less distraction from the many economic positives we've highlighted here.


*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


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