So as the discussion heats up on Capitol Hill, here is a look at how the financial landscape has changed thus far and the changes we might see down the road.
The End of the Standalone Broker-Dealer
Soon after I published my
Over the weekend, both of these remaining standalone
companies applied to the Federal Reserve for permission to change their structure to bank holding companies. The Fed approved this move and now here are several implications of it:
The primary regulatory agency which will oversee these companies will now be the Federal Reserve rather than the Securities and Exchange Commission (SEC), thus their capital and reporting requirements will significantly change. Morgan Stanley may have preempted the need to bulk-up on capital by selling a stake in the company to Mitsubishi UFJ .
Both of these companies can now build natural deposit bases. This could be done by building their own banks or perhaps by buying or merging with smaller institutions that have existing brick-and-mortar branch systems. Also, Goldman Sachs and Morgan Stanley could take something from the Merrill Lynch ( MER) model. (Merrill Lynch was recently acquired by Bank of America .) Merrill Lynch used a "sweep" function in its retail brokerage accounts, whereby all cash balances were swept into a Merrill Lynch-owned bank rather than money market accounts.
As bank holding companies, they will have direct access to the Federal Reserve banking system. This will allow Goldman Sachs and Morgan Stanley to borrow directly from the Fed at the lowest rates available.
The Disintegration and Convergence of the Financial Sector
Understanding the Financial Sector: Banks
" I broke down the banking world into three groups: money center banks, investment banks/brokers and savings and loan (S&L or "thrift") institutions. Here are few key points on the state of banks today:
Simply put, firms that were poorly managed, took excessive risk or were over-leveraged will no longer exist. That has already occurred with Countrywide (acquired by Bank of America in January), Lehman Brothers and Bear Stearns (acquired by JP Morgan Chase in March). Stay tuned for more shakeouts, as weak banks either go bankrupt or are acquired. For example, keep an eye on the state of S&L Washington Mutual .
The concept of the financial services conglomerate, which was once ridiculed due to the failure of the Citicorp-Travelers merger (1998) that created the Citigroup we know today, will now become more commonplace. Citigroup's failure is not due to the conglomerate concept but rather, execution of the business strategy and an internal cultural that promoted competition and divisiveness. Watch for Bank of America and JP Morgan Chase to create financial monoliths, by combining all of the elements of the financial sector under one corporate identity.
Risk avoidance will take priority over risk taking. Balance sheets will be more managed, more diversified and no single product or business will dominate.
TheStreet.com TV: Pitfalls of the Rescue
Debra Borchardt and Resolution Trust Corporation veteran John Lyons, CEO of Savills, highlight the problems with the government rescue plan.
To watch the video, click the player below:
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There are several regulatory changes that I expect to occur in the future. And as is usually the case, we will get overregulation. (Research
, which was instituted to prevent corporate malfeasance that occurred in companies like
.) Here are a few regulations I expect to see:
Federal mortgage lending standards: No longer will mortgages be handed out on a subjective basis. Objective standards such as maximum loan-to-value requirements will be established. Also, expect mortgage brokers to come under stronger regulation.
Commodity safe harbors: Currently, many over-the-counter (OTC) derivative agreements such as credit default swaps (CDS) have a "safe harbor" exclusion from the commodity regulations. I would expect Congress to take a hard look at these safe harbor rules, thus bringing OTC derivatives into a regulated environment.
SEC-CFTC: With the role of the SEC likely to become diminished, the often talked about merger of the Commodity Futures Trading Commission (CFTC) and SEC may become a reality.
So what does this all mean for investors and members of the financial services industry? Here is what to expect:
Risk taking will diminish at financial institutions (even more than it already has), as the focus will be on capital preservation and asset quality, rather than liability expansion.
We will have fewer, but larger and more diverse financial services companies.
The financial services compensation model will migrate from a risk/reward "Wall Street" compensation model to one of lower compensation via a risk-averse banking model.
The financial regulatory infrastructure and its cost will increase significantly.
At the time of publication, Rothbort was long GS, C and MER (with long calls), although positions can change at any time.
Scott Rothbort has over 20 years of experience in the financial services industry. In 2002, Rothbort founded LakeView Asset Management, LLC, a registered investment advisor based in Millburn, N.J., which offers customized individually managed separate accounts, including proprietary long/short strategies to its high net worth clientele.
Immediately prior to that, Rothbort worked at Merrill Lynch for 10 years, where he was instrumental in building the global equity derivative business and managed the global equity swap business from its inception. Rothbort previously held international assignments in Tokyo, Hong Kong and London while working for Morgan Stanley and County NatWest Securities.
Rothbort holds an MBA in finance and international business from the Stern School of Business of New York University and a BS in economics and accounting from the Wharton School of Business of the University of Pennsylvania. He is a Term Professor of Finance and the Chief Market Strategist for the Stillman School of Business of Seton Hall University.
For more information about Scott Rothbort and LakeView Asset Management, LLC, visit the company's Web site at
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