Wall Street Faces Capital Shortfalls, Pay Cuts in Banking Bill

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April 29, 2010, 2:29 PM EDT
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By Dawn Kopecki

April 29 (Bloomberg) -- JPMorgan Chase & Co. and Goldman Sachs Group Inc. are among U.S. investment banks that may be forced to raise an additional $250 billion in capital, cut executive pay and divest some of their most lucrative assets under a bill on the U.S. Senate floor today, analysts say.

A two-page provision tucked inside the 1,558-page bill on April 21 would change the structure of about 40 of the largest U.S. investment banks by forcing them to spin off their derivatives businesses. Another measure added this month would require derivatives dealers to maintain a “fiduciary duty” to municipal, pension and retirement plan investors, which some analysts say would wipe out that market altogether.

“The bill has moved so far left so hard, that it’s caught everybody by surprise,” said FBR Capital Markets analyst Paul Miller, a former examiner for the Federal Reserve Bank of Philadelphia. He said the bill was a “big, big hot button issue with voters.” “The Street now is just realizing that all of this stuff is getting in the bill.”

The spin-off provision would result in a capital deficit of $85 billion at eight of the largest global investment banks, analysts led by Kian Abouhossein at JPMorgan Securities in London estimated in a research note today. It prohibits swaps dealers from taking any federal assistance, including access to the Federal Reserve discount window or deposit insurance from the Federal Deposit Insurance Corp.

Spinning out Derivatives

At a minimum, the measure would require banks to spin out their derivatives business into a separately capitalized affiliate, analysts say. It was actually designed to force about 40 of the largest U.S. swaps dealers that also have federally insured banks to divest all swaps activities, said Courtney Rowe, a spokeswoman for bill sponsor Senator Blanche Lincoln, who sponsored the bill.

“This would be a sweeping change to our financial system and it was introduced 11 days ago without a hearing, without a study on its impact,” said Luke Zubrod of Pennsylvania-based Chatham Financial Corp., which advises more than 1,000 firms on derivatives.

If passed, analysts say the provision would drive business to foreign broker dealers that don’t take deposits in the U.S., such as Societe Generale, France’s No. 2 bank by market value. The Securities Industry and Financial Markets Association, which represents Citigroup Inc., Bank of America and other large derivatives dealers, estimates the provision would require as much as $250 billion in new capital.

“We continue to believe that the proposed regulatory changes would have a significant impact on global return on equities, declining from 19 percent pre-regulation to 12 percent,” Abouhossein wrote. “Given the political pressure in various geographies, we believe investment bank compensation reduction would be a key driver” to boost profitability.

‘Banks Should Be Banks’

Lincoln, an Arkansas Democrat, said she may not have the votes to pass the measure, and several other amendments are pending in the Senate that would potentially separate certain investment-banking activities from the traditional business of taking deposits and lending money.

“Banks should be banks,” Rowe said. “We’ve heard from Arkansans, especially our community banks in Arkansas, that they need a level playing field.”

Analysts say they fear that anger over Wall Street may drive support for more burdensome amendments, like reinstating Glass-Steagall-like regulations that separated investment and commercial banking.

“There really is a new kind of political model at work here,” said Brian Gardner, an analyst for KBW Inc. in Washington and a former staff director for Louisiana Representative Richard Baker, who was chair of the House Financial Services committee sub-committee before he left Congress in 2008. “The dissatisfaction with Wall Street and then the Goldman news has just changed the political dynamic.”

--Editors: Linda Shen, William Ahearn.

To contact the reporter on this story: Dawn Kopecki in New York at dkopecki@bloomberg.com.

To contact the editor responsible for this story: Alec McCabe at amccabe@bloomberg.net.

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