President Barack Obama's latest broadside against big banks may have more bark than bite.
Obama's plan to limit banks' size and risky trading has spooked investors, but analysts say it would have only marginal effect on institutions like JPMorgan Chase, Bank of America and Citigroup — and would be hard to enforce. And it's not clear the rules would reduce taxpayers' risk of having to bail out another big bank.
The White House has yet to provide details of the plan outlined Thursday. But attention has centered on Obama's effort to bar the biggest banks from doing what's called proprietary trading. That's when banks use their own money to make high-risk bets. If those bets go bad and a bank goes under, taxpayers could be on the hook.
Fearing the Obama plan might reduce bank earnings, investors reacted by dumping financial stocks Thursday, helping send the Dow Jones industrial average down 213 points. The pessimism continued Friday, with the Dow losing more than 216 points. Also weighing on the market were corporate earnings reports that failed to meet investors' expectations.
The proposed overhaul marked Obama's latest effort to more tightly police the nation's largest banks. Last week, the president proposed a tax on banks to recoup billions in bailout money that was handed out at the height of the financial crisis in 2008.
The moves come as banks face increasingly hostile rhetoric from Obama. The president has called bankers "fat cats" and vowed to defeat the banking industry's lobbying efforts against financial reforms.
Still, several analysts called Wall Street's reaction to the latest proposals overkill.
One reason is that most big banks derive only a tiny fraction of their revenue from proprietary trading. At JPMorgan Chase & Co. and Bank of America Corp., for instance, proprietary trading brings in 1-2 percent of revenue, according to a Citigroup report. Less than 5 percent of Citi's revenue comes from proprietary trading. The figure is 3-4 percent for Morgan Stanley and less than 1 percent at Wells Fargo & Co.
"Proprietary investment restrictions probably won't have a huge impact on most banks," said Douglas Elliott, fellow at Brookings Institution and a former investment banker. "That's a pretty small part of what banks do."
Elliott said much will depend on how lawmakers write the legislation, which has yet to be put even in draft form.
Citing banks' limited proprietary trading activity, Citigroup analysts Keith Horowitz and Ryan O'Connell said in a note that the effect of Obama's proposal "may be less severe than expected."
The banking industry has reacted sourly to Obama's proposal. Edward Yingling, president and CEO of the American Bankers Association, said his members are "very concerned" about it.
One worry is how the limits on a banks' size would affect their competitiveness against large foreign rivals like Barclays Plc, Royal Bank of Scotland and Deutsche Bank. Of the biggest 50 banks in the world by assets, only six are U.S.-based, Yingling said.
"We've been a world leader in financial services, and we need to be very careful about doing something to undermine that," he said.
Several U.S. banks said they need more details of Obama's plan before they assess its effect. Bank of America said it's already acted to scale back risk. That includes no longer issuing complex financial products known as derivatives, spokesman Scott Silvestri said.
At Wells Fargo, proprietary trading "is a non-issue," spokeswoman Julia Tunis Bernard said.
"Products and services that help our customers succeed financially are core to our business, not risky proprietary trading," she said.
Obama's proposal would also prevent banks that take federally insured deposits or that borrow from the Federal Reserve from owning or investing in hedge funds or private equity groups. That raises questions about JPMorgan's ownership of Highbridge Capital, a London-based hedge fund that manages more than $20 billion. The fund, however, is funded solely with client money. So it's unclear what effect Obama's proposal would have on the bank.
JPMorgan declined to comment.
Some banks would be affected more than others. Goldman Sachs Group Inc., for example, has long been among the most aggressive trading firms on Wall Street. On Thursday, Goldman reported a $4.79 billion quarterly profit, the biggest three-month gain since the bank went public in 1999 and one generated largely from risky trading in bonds, commodities and currencies.
Proprietary trading accounts for roughly 10 percent of Goldman's yearly revenue. That works out to $4.5 billion based on the company's 2009 performance. Adjusted for expenses, the new rules could, in theory, cost Goldman $1 billion in annual profit, according to the Citigroup report.
David Viniar, Goldman's chief financial officer, downplayed the impact of the new rules, calling proprietary trading "a very small part" of Goldman's business.
Other analysts warn Obama's proposal could cause serious damage to banks. Meredith Whitney, an analyst who predicted much of the industry's tumult in recent years, said the new rules could hammer banks' trading profits.
"Our bet: This goes through, and it will not be pretty for banks or consumers," Whitney said of Obama's proposal in a report.
Enforcing the restriction on proprietary trading could be difficult. That's because defining which trades are proprietary and which aren't isn't always clear, said Daniel Alpert, managing partner at the investment bank Westwood Capital LLC, which invests in banks.
"Banks buying and selling securities is just like anybody who buys and sells inventory," Alpert said.
He said banks can buy securities they intend to sell to clients but sometimes hold them because there isn't enough demand.
A big question is whether the proposed rules would make the financial system — and by extension U.S. taxpayers — safer.
Scott Talbott, chief lobbyist for the Financial Services Roundtable, a trade group whose members include the largest banks, said restricting proprietary trading could do more harm than good by limiting banks' ability to reduce or offset risk.
"You're eliminating a tool in the arsenal to manage risk," Talbott said. By doing so, "the banks are going to be more at risk, and that's not the goal right now."
Others say Obama's proposal doesn't go far enough.
John Boyd, a finance professor at the University of Minnesota, said the financial crisis had many causes beyond trading — including the repackaging of mortgages and banks taking on so much risk that they nearly collapsed the system.
"If all we're talking about is limiting proprietary trading, it's simply not adequate," he said. "The fundamental problem is too big to fail, and until that's dealt with in a serious way, we're going to have problems."
Wagner reported from Washington.
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