In Barclays’ latest US Portfolio Strategy Weekly note, the firm discusses financial reform, and concludes that the bill — as it currently looks — errs too far on the side of stability and the expense of financial regulation robustness.
Of course that’s Barclays’ view, and naturally the same point that’s a bug in their eyes would be a feature in the eyes of those writing the legislation.
We don’t wish to play that debate here, though the firm usefully lays out four key ways Wall Street is likely to be affected.
The CFPB (Consumer Financial Protection Board) is likely to have considerable independence; this was Senator Shelby’s major focus and, given the inability to reach a compromise, it seems likely that the Democrats and Administration will not move much on this issue. In our view, this points to reduced consumer credit creation.
Derivatives are likely to be heavily biased towards exchange trading, though the swap
subsidiary spin-out seems a likely point of compromise. The theme that appears to be
running through Washington is that the regulators are capable of making value
judgments on which derivatives lead to the betterment of society and which do not.
Normative economists like Thorstein Veblen (The Theory of the Leisure Class) would be
while Milton Friedman would be appalled. As we look to the implementation of derivatives legislation, we are quite concerned that poorly quite pleased, constructed value judgments will stifle efficiency and innovation. The outcome seems likely to be a negative for financial sector earnings and credit creation.
Securitization markets, particularly home lending, seem likely to remain impaired. The current wording requires 5% risk retention; given a $12 trillion dollar market, this implies an additional $600 billion of capital. As there are no provisions for the GSEs in the Dodd Bill, we struggle to see how non agency securitization origination develops after this legislation. Compromise and change seem likely and, given current housing demand, this won’t be a near-term issue; however, in our view, it implies impaired credit creation and a continued transfer of private debt to the public sector for years to come.
The Volcker Rule seems likely to pass without changes to the current wording. It goes without saying that this is a risk to the earnings of large financials, with all sorts of unintended consequences. Our interpretation of Tuesday’s hearings is that law makers have little understanding of market making and facilitation. While the current chairman of the Financial Stability Council may have a better understanding of the capital markets and risk transfer mechanisms than the Senate, he will not be the Treasury Secretary forever. In the last 25 years, we can think of plenty of candidates who would struggle in this role. This implies significant implementation risk, in our view.
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