Banks And Brokers To Suffer From Increased Regulation
The Dynamic Wealth Report
July 25, 2008
A Rally In The Bank Stocks - What To Do Now
Did you see the rally in bank stocks earlier this week?
Don’t be fooled. It won't last long. I’ll only think differently if we get some
great follow through – and I’m just not seeing it. Bank stocks have been
falling for the last year. We’ve said it time and time again, stay away
from the banking stocks.
First it was sub-prime loans. Then it was the credit crisis. Then Bear
Stearns collapsed. Rumors about Lehman are now followed by concerns over
Fannie Mae and Freddie Mac. Don’t touch these stocks.
Just look at this chart of the XLF.
You’ll notice that I used a long term view. Just because the market has
rallied over the last few days doesn’t mean we should jump right back
into the quicksand.
You’d think we’d be through the banking mess by now. But we’re not. I’ve
got new concerns that many haven’t thought about. These new concerns are
being caused by the Government in a lame attempt to help.
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It happens all the time.
Markets always move to an extreme. Then when they blow up everyone looks
to the government to save their hide. This time is no different.
Unfortunately government assistance comes with strings attached.
Just look at the SEC. They weren’t even a glimmer in anyone’s eye until
after the stock market crash of 1929. That opened the door for
subsequent securities regulations and rules.
Today is no different.
Just last week Fed Chairman Ben Bernanke indicated that the emergency
lending provision they put in place for Broker Dealers might be
extended. They hope – and that’s all it is, hope. The hope is that the
financial markets would view this as a supportive move.
Unfortunately this is the first step towards permanent government
involvement. All it’s going to do is add additional restrictions and
regulations.
So how might this impact the market?
If broker dealers become more regulated by the government, the first
thing to change will be capital ratios. Right now as the big broker
dealers operate, their oversight is voluntary between the SEC and the
company.
It’s likely the first move government would make would be to increase
minimum capital requirements. They dictate these ratios in the
traditional banks, why not the broker dealers. By implementing mandatory
liquidity levels all you’re going to see is their business model
seriously challenged.
What do I mean?
Follow me here for a moment. A broker dealer has a certain amount of
money – it’s their capital. This capital allows the company to place
trades on behalf of their clients, make loans, provide margin, and
basically run the business. It also allows them to enter into profitable
financing transactions with their corporate clients. In reality their
capital is rarely at risk (on certain transactions) but it serves as an
important backstop. Capital requirements limit the amount of leverage
broker dealers can use.
I know it’s confusing. Here is what you need to know.
If capital requirements are increased broker dealer profits will fall.
If profits fall, company values fall. Why pay twice as much for half the
earnings?
And that means your stock will head lower.
Realistically, if a broker dealer has their capital requirements
increased they have only two options. First, they can raise more money.
Not a good thought in today’s market environment. What investor wants to
see a company they own dilute ownership?
The only other option is to reduce their leverage. If they reduce
leverage they can’t process the very transactions they make money from. This means lower profits.
What companies will be impacted most by this government oversight? The
list is long, but here are the top names: Goldman Sachs (GS),
Merrill
Lynch (MER), Morgan Stanley (MS), and Lehman Brothers (LEH).
Before taking a position in any of the financial stocks everyone needs
to know this new challenge. Here’s the interesting part . . . this
government oversight is only starting to be discussed. Who knows what
other restrictions the government will place on the broker dealers. I’d
wait for these new developments to ripple through the industry before
taking any position in these stocks.
• SunTrust Bank (STI) was upgraded to “outperform” by two firms
this week. Despite Morgan Keegan and Robert W. Baird’s upgrade the stock
is down more than $3.
• Piper Jaffrey downgraded Washington Mutual (WM) this week. Apparently
the stock falling from its high of $40 to less than $4 is a good reason to sell.
• Piper Jaffrey initiated coverage on Raser Technology (RZ). The analyst
gave the company a “Sell” Rating. Why cover a company if you think
people should sell it?
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