In the most recent presidential debate Mitt Romney further expressed his opinion in regards to the Dodd Frank Act. He claimed that if elected, he intends to revoke the act. Although I do not believe the act will be revoked, it is highly probable that he will make amendments to it if elected. This article outlines the current legislation of the Dodd Frank Act and focuses on what effects the Volcker Rule has on some of the nation's largest financial institutions. The institutions discussed in this article include: Morgan Stanley (MS), JPMorgan & Chase Co. (JPM), Goldman Sachs (GS), Bank of America (BAC), and Wells Fargo & Company (WFC).
Dodd-Frank, An Overview
The Dodd-Frank Wall Street Reform and Consumer Protection Act (aka FINREG) was a result of the 2008-2009 financial crisis, where it was evident that reform in the financial industry was necessary. The act was reviewed in December of 2009, but not placed in effect until July 21, 2010. It is the most comprehensive financial regulatory reform measure since the Great Depression. Here is a brief outline of the key focus points of reform covered in this act:
- Financial Stability and Reform
- Agencies and Agency Oversight Reform
- Securitization Reform
- Derivatives Regulation
- Revision to the Investment Advisers Act
- Credit Rating Agency Reform
- The Volcker Rule Provisions
- Compensations and Corporate Governance
- Regulatory capital requirements
First in Line for Revision, The Volcker Rule
If Mitt Romney is elected, I strongly feel one of the first provisions to be revised will be the Volcker Rule. The Volcker Rule was not in the original House bill, yet under the Obama administration the rule was endorsed in January of 2010. The main goal behind the Volcker Rule was to exercise control that would augment the reduction of systematic risk through prohibiting majority proprietary trading by United States banks and their affiliated subsidiaries. In addition, the Volcker Rule restricted FDIC covered institutions from owning or investing in any hedge funds or private equity funds.
Positive Effect for Bank Stocks
The Volcker Rule affects a wide array of financial institutions across the country, but specifically puts a damper on large financial institutions. The primary disadvantage is their own trading activity is heavily limited, with restrictions permitting them to invest no more than approximately 3% of their current net asset value in any private equity or hedge fund. However, lighter restrictions on proprietary trading and allowing them to allocate funds to asset classes and funds of their choosing would greatly help increase market value per share of a wide array of large institutions. The revision of the Volcker Rule has the capability of doing so.
MS, JPM, GS, BAC, & WFC: All Feeling the Effects
All of these banks' operations have been hit hard in different ways. Here are several examples of how a few of these banks have been affected:
- GS was forced to abide by the rule and as a result sold part of its holdings in hedge funds. It was disclosed that during the first quarter of 2012, the bank redeemed hedge funds valuing to nearly $250 million.
- Following this, GS plans to exit positions of approximately 10% of various hedge fund holdings each fiscal quarter until the end of the second quarter in 2014.
- In addition, Bank of America, JP Morgan Chase & Co., Wells Fargo & Company, and Morgan Stanley are all reducing their investments in hedge funds and private equity firms as well.
- Another prime example is MS's infrastructure fund, which was created specifically to allocate funds to asset classes covering roads, airports, power grids, and electricity transmission networks, yet legislation is dramatically affecting its growth.
- Aside from investing in infrastructure, the goal of this fund was to provide investors with low-risk returns in conjunction with a long-investment horizon. However, given the nature of it being private equity associated assets, they are extremely less liquid than stocks and bonds.
- As a result of the Volcker Rule, MS is forced to cap their contributions to infrastructure by nearly 7%, because they must comply with the 3% threshold and given they contribute roughly 10%.
These are just a couple of examples of the implications the Volcker Rule has posed for large financial institutions. There are far more you will come across in research, yet the end conclusion will still remain the same. It is a fact that big banks are suffering from the Volcker Rule. If revised, I feel that large financial institutions will be capable of gaining significant upward momentum because they would have the lighter legislation needed to allocate funds appropriately, trade in manners that are evidently necessary to augment investors' wealth, and lastly magnify market value of their common stock.