Financial Reform Nothing for Wall Street to Cry About

Banks exhale, return to form, as regulatory overhaul nears passage.

July 15, 2010— -- With passage of the Dodd-Frank financial reform bill appearing to be a lock today, one might expect the mood on Wall Street to be somber. Instead, the financial industry is feeling as though it dodged a bullet, industry recruiters said, pointing to a recent upswing in hiring.

That relief is seen in a whirlwind rally with the Dow up 7 percent in six trading sessions through Tuesday and in the fact that investment bankers and traders are back in demand. If financial overhaul was supposed to spoil the party, it seems as though Wall Street didn't get the memo.

"The rules change but they don't end the game," said Lawrence Kaplan, a Washington, D.C.-based attorney in the bank regulatory practice at the law firm of Paul, Hastings, Janofsky & Walker.

The regulatory legislation has drawn sharp criticism from conservatives (too costly, doesn't address Freddie Mac and Fannie Mae problems) and from the liberals (too toothless) in recent weeks as the finish line came into view. "The banks realize this could have been much worse," one securities headhunter said. "Hiring, across the board, has taken off, especially relative to 18 months ago," the recruiter said.

The optimism on Wall Street stems, in part, from a long looming regulatory crackdown -- a big unknown -- giving way to closure and clarity, industry members explained. A U.S. corporate earnings season that is expected to be solid, as well as a European bailout plan that seems workable, are also factors seen as sparking the latest rally. The Dow closed up Wednesday, although only barely so with the S&P 500 closing slightly down. But banks stocks are getting a boost. JPMorgan Chase just reported a blowout quarter. Hedge funds, meanwhile, are being extended more leverage as banks loosen lending standards, a Fed survey showed.

Reacting to the most cataclysmic financial crisis in nearly a century, U.S. lawmakers have spent the past 22 months rebuking bankers, probing their alleged misdeeds and hammering out new laws aimed at avoiding future meltdown. Still, some of Wall Street's worst fears -- no longer being able to deal instruments such as credit default swaps, for example -- were put to rest as the bill became finalized. The controversial "Volcker Rule," named for Obama adviser and former Fed Chairman Paul Volcker and aimed at preventing banks from engaging in certain forms of hedge fund-style trading, ended up being watered down.

Indeed, banks will have as long as 12 years to ultimately rid themselves of proprietary trading businesses and hedge fund investments, Kaplan said.

No Getting Off Scot-Free

Another key reason Wall Street is upbeat: Most of the rules are still to be written, giving the banks more time to influence the process and stave off drastic changes.

Eleven regulatory agencies will be tasked with formalizing 243 rules. Many of them are the crucial measures cutting to the heart of what caused the crisis in the first place, such as deciding how much, at a minimum, actual capital banks need to keep on their books versus what they can borrow on a daily basis to stay afloat.

In the case of banks requiring bailout funds in late 2008, many of the institutions were not so much insolvent as they were temporarily illiquid, meaning that, in some cases, with respect to their overnight borrowing, they had bitten off more than they could chew on a short-term basis.

Simon Johnson, MIT professor and among the most vocal critics of Wall Street, blogged recently that the banks "have won completely – here we go again." Even the right-leaning Wall Street Journal editorial page Wednesday said of the regulatory package " ... the biggest financial players aren't being punished or reigned in."

But not everyone agreed that the Street is doing a victory lap.

Scott Talbott, a lobbyist with the Financial Services Roundtable, said "anyone who thinks this legislation is a gift basket to Wall Street is sorely mistaken. There are a lot of things in the bill that will severely impact the banks' bottom lines and their ability to lend. No one on Wall Street is happy about the negative impact of this bill, trust me."

Randall Guynn, head of the financial institutions practice at the law firm of Davis Polk & Wardwell, also disputed the notion that bankers and traders were spared the rod, so to speak.

"Institutions are going to be subject to more oversight, and more stringent capital and collateral requirements," Guynn said. "Those changes and the Volcker rule could cause banks to exit certain businesses, such as hedge funds and private equity.

"In terms of preventing another AIG type catastrophe, the bill goes a long way toward accomplishing that."