1/21/2010
By David Silver, Research Analyst

On the morning of January 21, President Obama announced his idea to restrict the size and scope of financial institutions by preventing proprietary trading, which is investing on behalf of the bank itself.  There were some good things that he said; especially that Main Street's funds (which are insured by the FDIC) should not be used to fund trading that many common investors have no access to. As such, the government is trying to limit financial companies from engaging in this sort of risky behavior. My question, however, is who decides what risky behavior is?  Is investing in credit default swaps (CDS) and credit default obligations (CDO) considered risky behavior?  Probably yes... What about giving a single mother a loan to buy a house?  Or how about giving a small business a loan to expand?  Are these items too risky?  And if so, what would make them less risky?

So now we have the bank "fee" to pay for the bailouts, even though most of the banks have already paid back their TARP borrowings, with interest, and an idea to essentially split the investment bank from a commercial bank.  So, what does it mean for the likes of Goldman Sachs (GS), JP Morgan (JPM), Citigroup (C), and Bank of America (BAC)?  Well Goldman will probably just sell off its commercial banking segment.  It is so small and was only created to be able to use TARP funds.  JP Morgan, Citi, and B-of-A have a completely different conundrum ahead of them. Maybe these sides of the businesses are IPO'd, and the respective companies get some sort of payoff.  What happens when these companies go through Goldman and have separate accounts there, looks like it could be a way around the expected restrictions. So proprietary trading is being hounded as the main reason for this potential legislation, but in its most recent quarter, proprietary trading accounted for less than 1% of JP Morgan's profits. 

It has been a hell of a year, from banks losing billions of dollars during 2008 and the beginning of 2009 to turning record profits by the end of the year. By splitting these companies, their profits are going to be slashed, which also means less tax revenue for the government.  Additionally, does anyone think that all these new "fees" that are being placed on banks won't just be passed on to the consumer?  The government indicated last week that it expects to raise $90 billion over 10 years on certain trades and other complex calculations (dealing with the company's liabilities relatively to cash and stock holder's equity). However, is that practice endorsing risky behavior?  If this move is to try to restrict risky actions from banks, then the $90 billion won't be raised over the next years.  That money is going to be used to pay for the automakers and AIG bailouts, but that still leaves the tax payers far in the red.  It also opens the door for other profitable industries (oil companies, drug makers, hell IBM made a record profit of $13.9 billion during 2009, are they next?) to be taxed to either help pay TARP or pay down the deficit. 

It is also amusing that the government is trying to tell these companies how to run a business, when the U.S. government has not "made money" since 2001.  At that time, the Congressional Budget Office expected the U.S. government to run a surplus of between $800 billion and $1.2 trillion dollars between 2009 and 2012.  Now, we are expected to run a $1.5 trillion deficit over the next three years.  So let's put the fate of the country, and every business in it, in the hands of people that have found a way to make a $2.0 trillion swing happen in eight years.

David Silver
Wall Street Strategies