Looming Financial Reform Slams Bank Shares

Bank stocks tumble as finanical reform looms
Bank stocks tumble as finanical reform looms

Bank stocks tumbled Monday as the U.S. Senate prepared for a key procedural vote on financial regulatory reform. Today's vote would be the first major test of the Senate's backing for the Obama administration's proposed reform package. The sweeping bill would break up too-big-to-fail firms, raise capital requirements and potentially deprive Wall Street of much of its lucrative derivatives business.

Bipartisan rigidity has slowed the movement of Sen. Christopher Dodd's (D-Conn.) Restoring American Financial Stability act through the Senate. The House of Representatives passed its own version of the bill last year, while the Senate version has proceeded in political fits and starts since its unveiling in mid-March.

But having put health care reform behind it, the White House has made clear that financial regulatory overhaul is its top priority. Last Thursday, from a podium in New York City just a short subway ride from the financial district, President Obama delivered his biggest speech to date on the topic.

That address came a week after the Securities and Exchange Commission charged Goldman Sachs (GS), Wall Street's biggest investment bank, with securities fraud, upping the administration's ante against the regulatory status quo.

A Potential Loss of Lucrative Businesses

As for stocks, the broader market managed to absorb the financial sector's sell-off Monday. Better-than-expected results from Dow component Caterpillar (CAT) helped keep the Dow Jones Industrial Average (%INDU) just barley in the green. The tech-heavy Nasdaq Composite ($COMPX) and broader S&P 500 ($INX) were slightly lower as the Senate vote neared. True, the S&P 500 lost 5 points, or 0.4%, as financial shares weighed it down. But that's a far cry from the height of the financial crisis when the sector led the market by the nose.

The S&P 500's financial sector, however, took a speculator's beating, shedding 1.5% in an essentially flat market. If the regulatory plan were to become law as it is now, banks such as JPMorgan Chase (JPM), Wells Fargo (WFC), Bank of America (BAC) and Citigroup (C) would have to separate their retail and investment baking business. The effect of that prospect on their stocks Monday was predictable: They shed anywhere from 2% to 5%.

After all, it was only last week that these firms all beat analysts' earnings expectations, thanks to their proprietary trading desks -- businesses they would be forced to give up.

$15 Million From Just One Deal

However, as institutions that don't take consumers' deposits, investment banks Goldman Sachs and Morgan Stanley (MS) have different fears. Rather than be cleaved into pieces, their concern is that the administration's reform bill would diminish or kill their cash-machine-like derivatives businesses.

Don't forget: Goldman Sachs earned $15 million in fees for creating and selling just a single derivatives deal for hedge-fund client Paulson & Co., according to the SEC's complaint. Any wonder shares in Goldman Sachs and Morgan Stanley sold off Monday?