Jim Jubak: Why bank reform is no problem for JPMorgan Chase

Jubak's Journal6/25/2010 7:30 AM ET

Why banks aren't afraid of reform

Yes, banks led us to the edge of global financial collapse, and yes, lawmakers are determined to rein them in with new rules. So why do bankers seem so cocky?

By Jim Jubak

So is it just standard-issue Wall Street arrogance, or does JPMorgan Chase (JPM, news, msgs) know something?

The bank, which has emerged from the financial crisis as one of the strongest big banks in the United States, is pressing ahead with negotiations to buy a big Brazilian hedge fund and private-equity group. JPMorgan Chase is in talks with Gávea Investimentos, which manages about $5.3 billion in assets.

Meanwhile, Congress is pressing ahead with a financial-reform bill that includes the so-called Volcker rule, which would limit banks' own trading and limit their relationships with hedge funds and private-equity vehicles. (An apparent deal was reached this morning, with final Senate and House votes still to come.)

JPMorgan Chase already controls Highbridge Capital Management, a $21 billion hedge fund, and private-equity group One Equity Partners.

Does JPMorgan just have a lot of faith that the banking industry's army of lobbyists will once again prevail and remove anything truly dangerous to the status quo from the bill?

Or does JPMorgan know that the fix is in and that no matter what our elected officials vote to do, when the rules are finally written by the folks who theoretically regulate the financial sector, the result will be change that banks can believe in.

I'd pick the latter.

2 chances to mute reform

The financial industry knows it gets two shots at this. The first, in the halls of Congress, isn't likely to prevent passage of something with a few teeth -- enough so that representatives and senators can tell voters in November that they fought for them against big, bad Wall Street. (But not so many teeth, of course, that members of Congress will jeopardize their ability to fund their campaigns with Wall Street money or find work in the financial industry once they are out of office.)

The second shot, out of public view, will take place in the halls and offices of the regulatory bodies that write the rules that implement the often-vague laws that Congress passes. JPMorgan Chase and other big banks are betting that when the rules are written, they will permit the activities that banks deem crucial.

The track record suggests the big banks are almost certainly right. If that's true, it means there are some bargains out there among bank stocks that have been sold off because investors think financial regulation might have real teeth.

Let me start by explaining why financial regulation with teeth is unlikely. And then I will end this column by identifying three U.S. bank stocks to put on your watch list for purchase during the summer doldrums to come. (To keep track of my watch list called, cleverly enough, Jim's Watch List, go here.)

Minimal exceptions that add up

The Volcker rule, first proposed in January by former Federal Reserve Chairman Paul Volcker, an adviser to President Barack Obama, is a great example of why the damage to financial-industry profits is likely to be less than many investors now fear.

The proposal would restrict proprietary trading by banks for their own accounts, unrelated to customers' needs. It would bar them from sponsoring hedge funds or private-equity funds. The stakes would seem to be huge. More than a quarter of all private-equity investments between 1983 and 2009 involved bank-affiliated private-equity groups, a recent study from Harvard Business School and global business school Insead found.

Banking lobbyists are fighting hard for an exemption. Big banks such as State Street (STT, news, msgs), Goldman Sachs (GS, news, msgs), Morgan Stanley (MS, news, msgs) and, yes, JPMorgan Chase want the rule changed to allow "de minimus" investments by banks in private-equity deals.

No big deal, right? Allowing minimal investments by banks wouldn't add significant risk to the financial system, and it would allow banks to invest in deals alongside clients. And that would convince bank customers that such deals were safe because the bank had its own money at risk. The interests of customers and banks would be aligned, the banks argue.

It's hard to imagine that even the banks buy that argument. If the investment is truly minimal, so minimal that it wouldn't increase a bank's risk, then how could it possibly convince the participants in a deal that the bank had significant skin in the game?

Continued: Stuffing the legislative sausage

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