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Financial industry's anxiety is rising over Obama's plan

The president's proposal, which includes curtailing high-risk securities trading by commercial banks, would curb practices that at some firms account for 25% of earnings.

January 27, 2010|By Nathaniel Popper
  • One major element of President Obama's proposal seeks to end risky investments at banks that hold the deposits of ordinary consumers. Above, members of Congress, economic advisors and others flank the president as he talks about financial reform.
One major element of President Obama's proposal seeks to end risky… (Olivier Douliery / Abaca…)

The financial sector has coolly navigated around government attempts to restrict executive pay and risky investments, but many on Wall Street worry that the Obama administration's latest proposal would hit the industry hard.

The plan announced by President Obama last week would curtail high-risk securities trading by commercial banks as well as their investments in hedge funds and private equity funds.

Analysts estimate that the proposal could slash earnings as much as 25% at a firm such as Goldman Sachs Group Inc. Industrywide, the hit to revenue could easily be in the billions.

"Culturally and profit-wise, this gets at what they do," Manny Korman, director of research at Buckingham Research Group in New York, said of the major Wall Street firms.

The industry may be justified in worrying. Although administration officials stressed that they didn't want to hurt the ability of American banks to compete, experts said the proposal, if enacted, could change the face of the firms that were at the center of the financial crisis.

"The aim is to try to rein in the big, systemically significant financial firms," said Jaret Seiberg, a managing director at Washington Research Group, which analyzes government policy for institutional investors. "If the president's plan went through exactly as outlined, then it would curtail a lot of business opportunities for the biggest banks. That would really hurt them."

The staging of the proposal's unveiling -- presented at the White House by Obama himself, backed by his economic team -- was designed to make a statement, Washington insiders said.

"The way they unveiled it clearly indicated that they intend to have a significant impact," said Lauren Weiner, spokeswoman for Americans for Financial Reform, a coalition of 200 consumer groups and other organizations.

The Financial Services Forum, which represents 18 of the country's largest financial institutions, has already begun aggressively lobbying against the plan.

Influential bank analyst Meredith Whitney described the proposal as likely to become law. In a report, she predicted a result that "will not be pretty for banks or consumers."

But given the slow progress of previous financial proposals by the Obama administration -- including a regulatory overhaul that was put forward last spring and is still pending in Congress -- many including Seiberg expressed skepticism about the plan's chances.

"You won't get this enacted in the Senate," he said. "You're going to end up with something more moderate at the end of the day."

But that view is far from universal on Wall Street.

In the clearest sign of the seriousness with which the proposal was received, big-bank stocks tumbled late last week and slumped further Tuesday. In the last four days, the shares of Goldman Sachs, JPMorgan Chase & Co., Morgan Stanley and Bank of America Corp. have each lost 10%.

Meanwhile, an index of stocks in regional banks, which generally don't have the sort of operations being targeted by the administration, closed at a one-year high after Obama presented his plan.

The proposal has two main elements. One would place new caps on the size of banks, limits that could force large commercial banks with investment bank units -- such as Wells Fargo, JPMorgan Chase, Bank of America and Citigroup Inc. -- to shrink themselves, perhaps by selling whole divisions.

The proposal's other major element seeks to end risky investments at banks that hold the deposits of ordinary consumers -- the sort of activity in which Wall Street firms such as Goldman Sachs and Morgan Stanley take part. Goldman and Morgan Stanley are still mostly investment banks, although they acquired commercial bank status during the financial crisis.

One part of the administration's push in this direction would ban commercial banks from making trades with their own money -- a practice known as proprietary trading.

Researchers at JPMorgan Chase estimated that at just five major banks, this ban could cost $13 billion in 2011.

Goldman and Morgan Stanley could avoid such damage if they gave up their relatively new status as commercial bank holding companies.

Goldman executives have said they aren't considering that option.

At investment banks, a large chunk of the revenue from proprietary trading typically goes directly into the paychecks of the traders.

As a result, traders are thinking that "in some way, shape or form, if this happens trading will be curtailed, and by definition that means less income both to the organization and to themselves," said Joshua Siegel, managing principal at StoneCastle Partners, a money management firm.

"There is talk about what's going to happen to proprietary trading guys -- whether they will be laid off or spun off," said Michael Karp, chief executive of New York executive recruiting firm Options Group. "There's a lot of chatter about the uncertainty."

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