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Bank Sell-Off Puts Premium on Regulatory Fears

Frustrated with a lack of progress in moving the existing measure forward, Dodd decided last weekend to draft his own reform bill. No word yet on where that stands.

The Volcker proposal would break up big banks and limit their operations, while the broader reform bill seeks to monitor them and the financial markets more closely. Rochdale Securities analyst Richard Bove told clients this week that the Volcker measure is "unlikely to pass."

"The government needs these banks to help fund the budget deficit and to assist large American corporations in expanding globally," Bove asserted in a note on Monday.

Besides putting a lot of weight in reforms that haven't been drafted and may not be passed, the bank stock sell-off ignores a much-improved outlook for diversified firms' core business (lending). For instance, while the housing market continues to bumble along, the Obama administration is offering more incentives for banks to boost small business lending. Small businesses make up a large part of the workforce and GDP, and can help drive the economic recovery, if adequate capital is available. Some banks, like Wells Fargo, are taking note.

The sell-off also disregards trends that portend higher levels of trading activity and investment banking services, like restructuring and M&A. As the outlook has skewed more toward inflation and higher interest rates, investors will also be looking for better returns on their money. Wells Fargo said this week it is hiring 1,400 brokers to take advantage of that trend. Competitors with big advisory operations, like Bank of America, Goldman and Morgan Stanley, will also benefit.

Bears may point to the continuation of high credit costs and unemployment, which will probably keep dragging on earnings in the quarters ahead. Still, it seems likely that loan-losses have peaked, and recent declines in unemployment levels have been encouraging.

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