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Senate Approved a Bill that Could Severely Impact Investment and Retail Banks

May 20th, 2010
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05.20.2010

Senate Approved a Bill that Could Severely Impact Investment and Retail Banks

original article written by Net Advisor™

WASHINGTON DC. The U.S. Senate approved a bill that could severely impact investment and retail banks. The current 1,566 page Senate Bill (SB 3217) includes legislation that would also overhaul the country’s financial system.

Under the flag of “Financial Reform” we are told by government that we need this. Arguably, what the government should do is create more transparency in the financial markets where trading in more “exotic” derivatives to be listed on major exchanges where all parties including the public can have price discovery for whatever typically non-liquid asset a party is holding.

The Senate bill could negatively impact major financial firms including JP Morgan, Bank of America, Morgan Stanley and Goldman Sachs where they could be prohibited from proprietary trading and investing in hedge funds and private equity funds.

  • “Large financial firms such as Bank of America and Goldman Sachs could be prohibited from proprietary trading and investing in hedge funds and private equity funds.”
  • “The Senate bill could force banks such as Goldman and JP Morgan Chase to spin off their profitable derivatives desks or risk losing access to the Federal Reserve’s emergency funds.”
  • “Large firms would also be forced to set aside billions of dollars in extra capital to ensure that they do not threaten the stability of the financial system.” — (Source: Reuters)

What the legislation seems to be doing is creating more government control over how banks and investment banks can operate their business. The bill also seems to reward smaller banks:

“The new consumer financial product bureau will not enforce rules for small banks’ products.” — (Source: Reuters)

Thus the government is favoring smaller banks which many are growing in financial trouble, and instead, government seeks to punish larger banks that are no longer under government control. This legislation basically moves the government into the “all knowing” position, telling banks how they should run their business.

All government needs to say is that we will not bail you out for making bad investment decisions again. The banks will either learn to manage risk better or they will fail. That is how business used to work in the USA. There is always somebody in line waiting to take a leadership role if one bank or competing business fails.

Initially, there are a couple big problems with the bill that could severally impact banking as we know it.

1. Big banks are all we have to compete with the big overseas banks. If we limit their ability to conduct sound business, they will be at a competitive disadvantage with the rest of the banking world.

2. Small banks could not compete with major foreign banks if their lives depended on it.

Quick example:

Let’s say you came up with an operating system, we will call it Linux. Let’s say this is a very good and a stable operating system. One problem is you are late to the market and the rest of the world is using another operation system, we’ll call it Windows.

So government issues legislation helping Linux and punishes Windows. What happens to Windows stock? It tanks.

Can a small player such as Linux that currently runs 1% of the worlds computers suddenly support roughly 91% of the world’s computers overnight or any time soon? No. Why? They don’t have the capital or infrastructure to do this, putting it at a huge competitive disadvantage with other systems.

This is how the U.S. government wants to run our big banks. The government doesn’t want a free market; they want to turn the market upside down. Bottom becomes top, and top becomes bottom.

How to Put Wall Street Out of Business Quickly: Insert Government

The Senate bill also seeks to ban companies such as Goldman Sachs (GS) “from proprietary trading and investing in hedge funds and private equity funds.” (Source: Reuters) This is what Goldman does, this is their business, and the firm uses their own money to trade.

If you take the trading out of GS and others, prevent them from investing in private equity start ups, existing private equity funds or investing in other hedge funds, you just wiped out the company’s ability to earn the kind of revenue they have managed to produce. Not to mention, all this multi-billion-dollar revenue brings in a lot of high paying jobs which in turn, those people buy things which produces demand for products and thus can create more jobs. This also produces tax dollars for the government which they desperately need.

Government Solution:

Kill the jobs, income and tax revenue, we just don’t want Wall Street firms to trade any more, nor do we want them to invest in other businesses, or provide capital to new business, or provide liquidity to financial markets.

America was built on private equity. We would not have Internet, i-phones, or any electronic devices if it weren’t for people and investment firms willing to take higher risks and invest in other businesses that traditional banks would not touch.

Reduce Liquidity, Increase Volatility

Next if the government does ban proprietary (“prop”) trading, that will also reduce liquidity to the financial markets. And if memory is short lived, when liquidity is dramatically reduced in financial markets, we can see more extreme movements (volatility) like we had on the May 6th Flash Crash.

These are just some of the risks that this piece of legislation could create.

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Financial Disclosure: At time of post, author and or author’s client(s) are long and short Goldman Sachs. Author has no current working relationship with any of the companies mentioned in this article.

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