Reform Looks Tougher — Financial Stocks Feel Heat

Financial regulatory reform suddenly gets very real. On a day where four stocks are advancing for every one declining, most big banks are down about 1 percent.

Concerns started mounting at the end of last week that the financial reform bill, now entering end game with a House-Senate conference, would be tougher than expected. Many big banks like Citigroup and JPMorgan were down Friday on a strong day for the markets.

Today FT has a front page story noting that Sen. Blanche Lincoln's proposal to force banks to create separately capitalized subsidiaries to house their derivative trading operations—a proposal considered dead two weeks ago—is now very much alive.

The reason: proponents have successfully argued that banks should not be funding risky derivative operations with FDIC-insured deposits. This argument passes the smell test for the average American, who does not even understand the business in general.

This would add huge costs to banks: where are they going to get the money to capitalize a separate subsidiary? You can't, presumably, just take it from the depositors. Are you going to float a $50 billion secondary offering?

By the way, one bank has a clear advantage here; guess who? Goldman Sachs, already has a separately capitalized subsidiary to trade derivatives.

Traders in financial stocks are pulling out their hair trying to handicap an event that, because of the surge in populist sentiment, is not handicappable. "Everything that was supposed to not happen, has happened," one frustrated trader told me.

The Volcker Rule, which would force banks to end proprietary trading, is also very much alive.

There are more fundamental reasons why banks would be weak: earnings will be pressured this quarter.

1) the trading business, which has been robust the last few quarters, will be much less so this quarter, particularly fixed income;

2) weak capital markets: equity issuance has been poor, and M&A activity has been low.

For this reason alone, expect analysts to start taking Q2 numbers down, beginning next week.

Bookmark CNBC Data Pages:



Questions? Comments?