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JPMorgan: The Bank That Kicked the Regulatory Hornets’ Nest

Financial reform, with the enactment of Dodd-Frank and the creation of the Consumer Protection Financial Bureau, hasn’t been the death by a thousand cuts that banks said it would be — but it has added uncertainty and taken bites out of their revenues.

Now, just when the nation’s financial institutions had largely adjusted to this brave new regulatory world, JPMorgan Chase‘s (NYSE:JPM) $2 billion-and-counting trading loss has put the Volcker Rule back at the top of regulators’ agenda.

And that’s the last thing investors in bank stocks needed.

The financial sector has led the S&P lower during the past month, as the JPMorgan fiasco added fuel to a fire touched off by the crisis in the eurozone. And it’s not just that the best risk manager on Wall Street — the bank that came out of the financial crisis smelling like a rose — had a complex bet on derivatives blow up in its face. True, that’s bad enough, shaking confidence in the wider industry.

No, it’s that the loss handed a cudgel to proponents of the Volcker Rule — a proposal that cuts to the heart of what was once an outsized profit engine for banks.

The Volcker Rule, named for former Federal Reserve chief Paul Volcker, would bar banks from making speculative bets that aren’t on the behalf of clients. Proprietary trading, owning or investing in hedge funds or private equity funds would be barred. The idea is that if these bets go bad and lead to catastrophic losses, well, the money the banks burned would have come from its depositors — funds that are insured by the Federal Deposit Insurance Corp. and backstopped by U.S. taxpayers.

In short, banks shouldn’t take risks with their depositors’ cash.

Make no mistake: That’s a good thing. But bank stocks sure don’t like it. Even as the Volcker Rule still is being written — and banks will have another two years to get in full compliance as long as they make what the Fed calls a “good faith” effort — Dodd-Frank and the impending rule already are taking a toll on revenues, as banks shut down trading on their own accounts and exit hedge funds.

“The passage of Dodd-Frank has changed the business models and profitability for many U.S. financial firms, especially large ones, as it has changed the services, fee structure, and limited the services financial firms can offer,” notes Frederick Cannon, analyst at Keefe, Bruyette & Woods, in a report to clients.

JPMorgan says its bad trade was in compliance; that it was a poorly executed hedge — a claim that has been met with skepticism and snickers. But whether that’s true is almost beside the point as far as investors are concerned. The potential damage to the broader industry lies in all the heat it has brought down.

The Federal Reserve, the Securities and Exchange Commission and the Commodities Futures Trading Commission are all investigating. Meanwhile, the Senate Banking Committee is grilling executives in hearings, the Federal Reserve Bank of New York reportedly is examining how banks are managing cash and we’re even hearing calls for the return of Glass-Steagall, the Depression-era law that split commercial banks from securities firms.

Lawmakers and regulators are saber-rattling over stricter interpretation of Dodd-Frank and a tougher version of the Volcker Rule. How much of that is political posturing in an election year and how much it ultimately costs banks very much remains to be seen.

But JPMorgan’s loss couldn’t have come at a worse time for bank investors. Regulatory uncertainty is an overhang on stocks, and investors won’t get a sense of how it’s going to play out until they get a look at the Volcker Rule. With no firm date set for the ink to dry, that’s something that could take all summer long.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2012/05/jpmorgan-the-bank-that-kicked-the-regulatory-hornets-nest/.

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