Banks: Wave These Profits Goodbye

Financial reform is grinding ahead, and one measure that was once a non-starter is making a strong comeback. According to the Financial Times, Senate Agriculture Chairman Blanche Lincoln's plan to force banks that receive government support to spin out their profitable swaps trading desks is now likely to pass, with "wise man"/ White House advisor Paul Volcker dropping his opposition to the plan.

The $28 billion honey pot
Banks have been fighting tooth and lobbyist to stop the plan, which they consider particularly harmful to their profitability. The sums at stake are enormous: The five largest banks in the over-the-counter (i.e., off-exchange) derivatives markets earned $28 billion in trading revenue from this activity last year.

The five banks are JPMorgan Chase (NYSE: JPM  ) , Goldman Sachs (NYSE: GS  ) , Morgan Stanley (NYSE: MS  ) , Bank of America (NYSE: BAC  ) , and Citigroup (NYSE: C  ) . Nearly two-thirds of the $79 trillion in notional amount of outstanding derivatives contracts at JPMorgan at the end of 2009 were swaps.

Do you have $85 billion to spare?
If the plan becomes law, banks would have to create a separate subsidiary for their swaps activity outside of the bank holding company; the rub is that the subsidiary would need to be capitalized separately. One analyst at JPMorgan has estimated investment banks would need to raise $85 billion in additional capital.

In addition, there is the fear that U.S. banks could lose business to more lightly regulated foreign competitors.

Bernanke as a contrary indicator
If the legislation were to pass, it would partially rebuild the wall between investment banking and commercial banking that was demolished with the repeal of the Glass-Steagall Act in 1999. My favorite Fed bank president Thomas Hoenig, head of the Federal Reserve Bank of Kansas City, supports Lincoln's plan -- contrary to Fed Chairman Ben Bernanke. That's enough to make me think the plan must be broadly sound. What do you think? Let me know in the comments section below.

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Fool contributor Alex Dumortier has no beneficial interest in any of the stocks mentioned in this article. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.


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