President Barack Obama’s plan to limit the size of banks and prohibit them from investing in hedge funds and private equity funds is a new way to reduce risk-taking and prevent a repeat of the credit crisis.
Under new rules bank holding companies would be barred from owning, investing in or sponsoring hedge funds and private equity funds. They would also be prohibited from proprietary trading which has been a huge source of profits for Wall Street firms in recent years. The new rules would also further curtail consolidation in the financial services sector, putting stricter limits on a firm’s market share of liabilities.
The new proposed plan to restrict the activities of commercial banks could have a significant impact on private equity and the hedge fund industry. While banks have cut back on their own private equity businesses in recent years, some remain very active. According to JPMorgan Chase & Co. analysts, this plan will cost Goldman Sachs Group Inc., Morgan Stanley, Credit Suisse Group AG, UBS AG and Deutsche Bank AG about $13 billion in revenue next year. Of the five banks analyzed, Obama’s proposals will impact Goldman Sachs the most, resulting in an estimated $4.67 billion drop in earnings in 2011. UBS stands to lose the least, Credit Suisse Group AG with revenue declining an estimated $1.92 billion.
Many firms, including Goldman, became bank holding companies to become eligible for government bailout money during the financial crisis. If Obama’s proposals become law, they would have to choose between being a commercial bank, taking customer deposits, and proprietary trading.
The details of the President’s banking proposal are still unclear. It is also unclear how proprietary trading activities can be effectively distinguished from Treasury activities and the risk-assumption inherent to market making. Some will argue that the proposals could create opportunities for the global hedge fund industry. Others will argue that this plan will create a growing concern about the possibility of liquidity in markets being reduced and the prime broker relationship being adversely affected. Also, that these restrictions are anticompetitive and will put United States banks at a disadvantage to foreign competitors.
Everyone might be right in one way or the other. One thing is for sure, the current crisis has shown that the threat imposed by “too big to fail” is simply too big for all of us to bear.