As Reform Takes Shape, Some Relief on Wall Street
The business that is likely to change most is the trading of derivatives, the complex instruments considered to be among the main culprits of the financial crisis.
These securities, largely traded in the shadows rather than on exchanges like stocks, propelled an outsize portion of trading profits at firms like JPMorgan, Goldman Sachs and Morgan Stanley in recent years. But the lack of disclosure and the absence of standard prices also meant that derivatives increased risk and volatility, while also making companies dangerously intertwined in the event of a crisis.
A Senate proposal calls for Wall Street firms to wall off their derivatives businesses and place them in subsidiaries requiring substantially more capital. That would be a major blow — but this provision faces opposition from the both the financial industry and federal banking regulators, and is likely to be shelved or watered down before final passage.
The most likely outcome, according to industry officials, is a compromise that would allow banks to continue offering derivatives to clients in order to hedge risks. Trading would be shifted to clearinghouses or onto exchanges, and banks would be required to put up more collateral to cushion against losses.
These changes would make the system safer and more transparent, but they would erode profitability in what had been one of Wall Street’s most lucrative areas. Mr. Ramsden, the Goldman analyst, estimates that the legislative changes could reduce the financial industry’s earnings by 4 percent, though individual firms could be hit harder.
Still, the derivatives sector is simply too much a part of Wall Street to just simply vanish, according to John R. Chrin, a former financial services investment banker and teaching fellow at Lehigh University.
“This legislation is not going to kill the business,” Mr. Chrin said. Even if profit margins are reduced, he added, they will still compare favorably to more traditional banking activities like commercial lending. Wall Street firms are already investing money to upgrade the computer systems that drive derivatives trading in order to make them more efficient, as a way to compensate for what are almost certain to be leaner times ahead.