What happened

Shares of leading U.S. multistate cannabis operators Green Thumb Industries (GTBIF -0.78%), Curaleaf (CURLF -4.30%), and Cresco Labs (CRLBF -4.14%) all plunged on Tuesday, trading down by about 13%, 11.4%, and 12%, respectively, as of 2 p.m. ET.

Those across-the-board declines eliminated most of the significant short-term gains those stocks made in recent days on the back of commentary out of Washington suggesting that the Secure and Fair Enforcement (SAFE) Banking Act could be passed during the lame-duck Congressional session. However, on Tuesday, those hopes were dashed.

So what

In recent weeks, there was a lot of optimism that the SAFE Banking Act's provisions -- which would indemnify national banks from liability in working with cannabis companies in states that have legalized the drug -- might pass Congress during its December session. Recently, it appeared as though there was momentum behind efforts to attach those provisions to the National Defense Authorization Act (NDAA) that Congress is working on now.

A SAFE Banking bill would be a mild positive catalyst for all U.S. multistate operators, as it would allow cannabis companies to take credit and debit card payments, and perhaps get lower rates on loans and other services from mainstream banks instead of relying on the more expensive financial workarounds they use today.

However, the efforts to get SAFE across the finish line ran into snags in both houses of Congress over the past two days. First, Senate Minority Leader Mitch McConnell blasted the move to attach the provisions to the NDAA, saying, "House and Senate Democrats are still obstructing efforts to close out the NDAA by trying to jam in unrelated items with no relationship whatsoever to defense."

At the same time, some legislators in House appear to be holding up the NDAA over disagreements regarding other provisions not related to the SAFE Act. Of note, the House passed a version of the NDAA earlier this year with the SAFE Banking reforms attached. But some legislators' desires for a "cleaner" bill could cause the SAFE provisions to be stripped out of the final version. 

Legalization advocates therefore continue to be disappointed, as the 60-vote threshold for passage in the Senate continues to be the big roadblock. At first, Senate Democrats had hoped to get a comprehensive legalization bill passed this year, considering that a clear bipartisan majority of Americans favor legalization. However, too few Republican Senators were willing to support the measure.

However, these cannabis stocks had risen in recent weeks amid other hopeful signs: President Biden recently signed a bill to increase marijuana research, he pardoned non-violent marijuana offenders back in October, and numerous legislators had displayed optimism over the chances that the SAFE Banking Act would pass in the lame-duck session.

Previously, cannabis stocks had sold off hard this year, not only due to disappointments on legalization, but also due to the effects of slower consumer spending, higher interest rates, and increased competition.

Now what

While it's still possible that the SAFE Banking reforms will pass this year, even if they do, it would not be a huge fundamental game-changer for these cannabis companies. Lower operating costs would be nice, but cannabis companies are still operating under the onerous tax regime of Section 280e of the IRS code. Because cannabis is a Schedule I drug under federal law, these companies can't deduct their normal operating expenses, so they are essentially taxed on their gross profits.

It's nearly impossible for them to be meaningfully profitable as long as that remains the case, and SAFE wouldn't change that. While their valuations have definitely been beaten down and these market leaders are posting nice profits on an EBITDA basis, their tax burden still makes these companies incredibly risky in a higher-interest-rate and recessionary environment.