There's a deep irony in the post-election bank stock rally: It's been fueled by hope that the Trump administration will ease regulations in the financial services industry, but there's reason to believe the regulatory landscape could get even worse for certain banks under the new president.
The banks that would be most affected are JPMorgan Chase (NYSE:JPM), Bank of America (NYSE:BAC), and Citigroup (NYSE:C). Not only are these three of the four biggest banks in the country, but they're also all universal banks, meaning they house both commercial and investment banking operations.
FORMER GOLDMAN SACHS PRESIDENT AND COO GARY COHN (LEFT) HAS INTIMATED THAT HE SUPPORTS BREAKING UP BIG BANKS. CHAIRMAN AND CEO LLOYD BLANKFEIN IS ON THE RIGHT. IMAGE SOURCE: GOLDMAN SACHS.
A commercial bank makes money principally by taking deposits and lending that money back out, profiting from the difference between its cost of funds and its interest on earning assets (i.e., loans and government securities). An investment bank, by contrast, makes money by issuing stocks and bonds for clients, advising customers on mergers and acquisitions, and buying and selling securities from and to institutional investors.
Traditionally, investment banks weren't allowed to commingle with commercial banks. This dates back to the Glass-Steagall Act of 1933, which, much like the Dodd-Frank Act of 2010, was passed in order to address issues that led to a banking crisis -- in that case, the Great Depression.
But this prohibition was formally eliminated by Congress in the late 1990s, spurred on by widespread deregulatory fervor and the 1998 merger between Citicorp and Travelers to create Citigroup -- the first universal bank to reemerge after six decades.
Since then, JPMorgan Chase, Bank of America, and other banks have bolted major investment banks onto their commercial banking operations. JPMorgan Chase is the combination of the Chase commercial bank and the JPMorgan investment bank, while Bank of America took its deepest plunge by purchasing Merrill Lynch during the financial crisis.
The bad news for these banks, however, is that there's growing support among policymakers to once again break universal banks into separate investment and commercial banking segments.
The most vigorous support for doing so comes from policymakers on the left -- people like Sen. Elizabeth Warren (D-Mass.). More troubling for these banks is that certain people within Trump's administration seem to be on the same page. And it's not just any ole person who thinks this -- it's Trump's top economic adviser and former president of Goldman Sachs (NYSE:GS) Gary Cohn.
Bloomberg News reported last week that Cohn "generally favors banking going back to how it was when firms like Goldman focused on trading and underwriting securities, and companies such as Citigroup primarily issued loans."
The benefit to Goldman Sachs if this were to happen would be considerable, as it'd effectively emasculate the investment banking operations of JPMorgan Chase, Bank of America, and Citigroup, which happen to be Goldman Sachs' principal competitors (in addition to Morgan Stanley). Alternatively, it's probably obvious that the picture isn't as optimistic for universal banks, many of which have consolidated and grown their investment banking operations since the crisis nine years ago.
It's impossible to predict if the administration will actually follow through on Cohn's preference. But either way, this goes to show that the current regulatory landscape for the bank industry is much more nuanced than one might otherwise have assumed given Trump's vows on the campaign trail to dismantle Dodd-Frank.
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