Who might win big or lose big in financial overhaul? Financial reform to mete out penalties, prizes

In the final details of financial reform, oversight of and limits on big banks could raise their costs, making it easier for small banks to compete.
In the final details of financial reform, oversight of and limits on big banks could raise their costs, making it easier for small banks to compete. (Spencer Platt/getty Images)
By Zachary A. Goldfarb and Jia Lynn Yang
Washington Post Staff Writers
Saturday, May 22, 2010

Even as the landmark financial bill passed by the Senate this week punishes some of the most famous companies in American finance, it may reward little-known firms that operate behind the scenes, below the radar or overseas.

The nation's biggest banks, from Goldman Sachs to J.P. Morgan Chase, stand to lose billions of dollars as they are socked with new fees and regulations and forced to shed businesses.

But their loss could be a gain for other firms. If the banks are forced to stop trading with their own money or spin off activities focused on financial instruments called derivatives, this business could move to hedge funds, which are far more lightly regulated, or foreign banks that don't face the same restrictions.

The biggest banks also will face new oversight and tighter limits that could raise their costs and make it easier for smaller banks to compete.

With its bill, the Senate is picking winners and losers throughout the financial industry and across corporate America. Although some will clearly benefit and others not, the ultimate impact of the legislation is not yet clear for all companies. And if in the end the new rules save companies from making the kind of mistakes that fueled the financial crisis, the costs imposed on even the big banks may be relatively modest.

Much could still change. Senate negotiators will meet with House counterparts to work out differences between the two bills.

"There is a sense of bailout burnout in the country. The public looks around and sees that instead of being shut down, the largest banks benefited from public assistance," said Brian Gardner, an analyst at Keefe, Bruyette & Woods. "That has translated into a desire to take out frustration on the large banks."

But the bill gives many firms something to celebrate.

The Senate bill does not go as far as lawmakers and consumer advocates had hoped in whittling down the size of large financial companies, but smaller banks and businesses outside the financial sector would, on balance, fare better. They would face comparatively few new restrictions.

Community banks, for example, would not have to pay the hefty regulatory fees exacted from larger banks and would be largely exempt from oversight by the new consumer protection bureau, assigned to prevent abuses in mortgages, auto loans and credit cards.

Retail companies would enjoy far more flexibility than before in deciding when to allow customers to charge purchases on such credit cards as Visa and MasterCard.

The broad outlines of the financial overhaul bill have been known for many months. But it is in the details of how the regulations would work -- and in the many ways senators changed the bill in the final days -- that could decide who wins and who loses in corporate America.

Two of Wall Street's leading investment banks, Goldman Sachs and Morgan Stanley, stand to lose the most. The Senate bill targets two major sources of their profit: putting together derivatives for sale and proprietary trading, or trading with their own money. Other top banks, including J.P. Morgan Chase, Bank of America and Citigroup, also make a lot of money from these businesses, although they are more diversified.

Major banks would also take a hit, because they would have far less power to charge fees to retailers for credit card purchases. And under a new formula, these banks would have to pay much more than they do now to the Federal Deposit Insurance Corp. for guaranteeing deposits.

By contrast, smaller community banks will pay less for the deposit insurance fund and largely escape oversight by the new consumer protection agency.

But these smaller banks would still be hit hard by new restrictions on a type of investment known as a trust-preferred, which many small firms rely on to meet requirements that they have enough a large enough financial reserve to cover possible losses.

"It will undermine the capital position of over 1,000 banks," said Ed Yingling, president of the American Bankers Association.

If the major banks are forced to spin off their trading desks, hedge funds could see a significant windfall under the bill, although it requires them to register for the first time with the Securities and Exchange Commission.

"Pure play hedge funds would be the big beneficiaries," said Raj Date, chairman and executive director of Cambridge Winter Center for Financial Institutions Policy.

Among the other winners would be derivatives companies, including the Chicago Mercantile Exchange, which have expertise in setting up the new clearinghouses required, and institutional investors, like pension funds, that would gain greater say over corporate boards, despite heavy lobbying from big businesses.

Other losers would include the credit rating agencies, which will face new legal liability if their judgments on the safety of investments turn out to be wrong.

Several industries which might have faced tough new federal rules have so far escaped. The bill, for instance, would not affect insurance companies very much, a victory for industry lobbyists who initially worried that lawmakers would lump the firms into the same category as big banks.

Industrial companies like General Electric and Honeywell also avoided the prospect of heightened regulation because of a last-minute amendment. The measure offered by Sens. David Vitter (R-La.) and Mark Pryor (D-Ark.) bars systemic risk regulators from examining companies that earn less than 85 percent of their revenue from financial activities.

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