Will Financial Reform Be Legitimate? (AIG, GE, GS, JPM, BAC, FNM, FRE)

Congressman Barney Frank and Senator Chris Dodd are not wasting any time after health care reform.  In a press conference this morning, the two well-known Democrats said financial reform was next on the agenda from Washington D.C.  The target for financial reform is now being set within the next month.  The target is for the new legislation to be sent to President Obama before Congress adjourns for the year.  Dodd noted that the propositions will harmonize the Senate and House reform bills, but again came the partisan slap that this will be passed through with or without Republican support.  Financial reform is needed.  Both sides agree on this, at least for now.  The question is whether financial reform will be legitimate reform that makes certain institutions utilities or whether it is illegitimate reform that in the end is just regulation on top of more regulation.

There is one giant notion and potential that is going to come into play here, and that pertains to historic US contract law.  The two today said that some large financial institutions would be unwound if they were not worthy of standing on their own as an attack on the “too big to fail” notion.    And then some creditors may get hit in the process.  This happens in bankruptcies routinely, but if the government starts to just seize firms that may be believed to be in trouble suddenly contract law is challenged that has been in place long before the reforms were removed which kept banks small in the first place.  Still, that is just one notion to consider here considering that states are already challenging the constitutionality of the healthcare reform.

The bills have much to work through far beyond some of these already mentioned issues.  The regulation is not just banks.  It is non-bank financial institutions, and in some extreme cases can apply to non-bank systemic companies.

Some of Dodd’s bill issues are supervision of hedge funds and derivatives trading, authority to handle too-big-to-fail financial institutions, a new consumer financial protection agency, a change to bank and financial regulators, investor protection, and the creation of a systemic risk regulator or council. There is also the creation of a Office of National Insurance and new regulation and oversight for Credit Ratings Agencies. .  Smoothing over issues this quickly is unfortunate, because there are many issues.  Dodd’s bill also includes regulation of non-bank financial companies and a break-up of large complex companies:
Authorized to require, with a 2/3 vote, nonbank financial companies that would pose a risk to the financial stability of the US if they failed be regulated by the Federal Reserve. With this provision the next AIG would be regulated by the Federal Reserve. That names American International Group, Inc. (NYSE: AIG) specifically.
Break Up Large, Complex Companies: Able to approve, with a 2/3 vote, a Federal Reserve decision to require a large, complex company, to divest some of its holdings if it poses a grave threat to the financial stability of the United States – but only as a last resort. Does this pertain to General Electric Co. (NYSE: GE) or not?  GE has said it is prepared to deal with regulation of broader regulation in some form, and it goes without saying that GE is actually an integral part of American business.

The trading regulations which have been proposed seem aimed directly at the likes of Goldman Sachs Group Inc. (NYSE: GS).  It just depends upon what is “proprietary trading” versus trading in the normal course of business.  Do J.P. Morgan Chase & Co. (NYSE: JPM) and Bank of America Corp. (NYSE: BAC) have keen and unique insights on consumer credit and business activity trends ahead of economic numbers based upon customer behavior?

Ratings agencies might have to reevaluate the major banks if the current propositions go through without any changes. If regulation automatically undoes all the extraordinary help that has been given in 2008 and then in 2009, imagine if the new regulation suddenly made healthy banks unhealthy all over again.
And what about the GSEs under conservatorship?  Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) would be defunct if the federal government did not want to include these as direct liabilities on the US balance sheet.  If unwinding any systemic-risk financial firms comes, it seems a safe bet that these firms will be unwound and relaunched as a utility-like company (or regional or financial-tier grouped companies).

We have already seen a dozen or so states file a suit against the health care reform that was just passed this week over Constitutional violations.  It is not without reason to believe that if the financial reform is too broad or too restrictive that suits could come from states or from a dozen corporations.  If these institutions can show that the regulations will make them unable to operate or that these will cost jobs and jeopardize financial health, then a series of suits to block this seem realistic.

Hopefully, these elected officials won’t come up with more taxing on investments and income, even if it just pertaining to “the rich folks” that the administration is so keen on targeting.  Investors already were unfairly targeted to help pay for health care reform.  A 3.8% tax on income from investments to help pay for health care…. yet not one damn penny taxing Big Macs, Cheetos, popcorn, Coke, Pepsi, pizza, beer and on.  The public has to see the link there… Is passive income from investing the cause of the issues ruining our healthcare system rather than the crud we eat in America as a whole?

As far as whether financial reform will pass or not, that seems almost a certainty.  Republican Senator Judd Gregg was quoted this week saying he is “100% confidant” that a financial rewrite bill will be passed in 2010.  The question is WHAT will be included that is nothing more than new taxes that are really no part of reform after these bills are merged.  It will be interesting to see if this round of reform is legitimate and real reform or if it is the debacle of what we saw in the healthcare reform.

Some reform is coming.  That much is for sure.  And much reform is needed.  We are the first to say that taxpayers should not have to support big companies in the future.  This is work in progress, or at least effort in progress.

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JON C. OGG