Friday, January 22, 2010

Bank stocks probably over-reacting to headline worries (GS, MS, JPM, C,BAC)

Bank stocks are off nearly 10% in just a couple days, taking a cue from President Obama's new threats to reign in activities at the largest US institutions.

After a major setback to his agenda in the Tuesday senatorial election in Massachusetts, the President went looking to pick a fight - his words, not mine:

''My message to leaders in the financial industry is to work with us, not against us,'' he said. ''If these folks want a fight, it's a fight I am ready to have.''

The finer points of the administration's plan will - like healthcare, like the stimulus - be figured out by someone else, but in general the idea is to restrict the investing and trading activities of banks that access the Fed discount window or rely on FDIC insurance, etc.  Again, these are "best-guess" estimates, as the details have yet to be determined.  Some are rightly pointing out that actions like this might not have prevented the financial sector meltdown anyway.  Bear Stearns, for example, wasn't accessing the Fed discount window or enjoying FDIC backing - they just bought a LOT of garbage.

The biggest worry is the possibility that "proprietary trading" will be curbed, and the main target here would be Goldman Sachs.  The estimate being thrown around is that principal trading accounts for 10% of revenue for Goldman, and probably a much higher % of net income.  Principal investments at other banks are likely closer to 2-4%, so the potential legislation will not be a serious hit to earnings.  Even Goldman has downplayed the impact on their earnings:

"I would say pure walled-off proprietary-trading businesses at Goldman Sachs are not very big in the context of the firm," David A. Viniar, the firm's chief financial officer, said in a conference call.

Some of the attempts to reign in risk-taking seem completely appropriate, as the administration said these steps were "in the spirit of Glass-Steagall," the former rule preventing commercial banks from engaging in most securities trading.  While people (myself included) applaud that effort, they also wonder whether this President is qualified to implement a truly massive re-order of the banking landscape, given his previous views of the financial industry and the private sector in general.  Writing in his book Dreams From My Father, Obama referred to his brief stint on Wall Street (a job he reluctantly took), as being "like a spy behind enemy lines":

Bank stock shareholders should take comfort that everyone from Geithner to Bloomberg to Barney Frank are coming out against this new attack on banks.  And even if some sort of new restrictions on bank involvement in private equity or principal transactions is enacted, the negative effect to earnings will be very small.

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