“Financial Reform:” Shareholders’ Way to Lose Value
By Jeremy Weltmer • Tuesday, May 25, 2010 2:25 pm
Corporate America is making one thing abundantly clear: the Obama administration is bad for business. Perhaps the best evidence of this can be seen from the changing patterns in campaign contributions as reported by The New York Times and The Washington Post: “Look, for example, at the campaign contributions of commercial banks — traditionally Republican-leaning, but only mildly so. So far this year, according to The Washington Post, 63 percent of spending by banks’ corporate PACs has gone to Republicans, up from 53 percent last year. Securities and investment firms, traditionally Democratic-leaning, are now giving more money to Republicans. And oil and gas companies, always Republican-leaning, have gone all out, bestowing 76 percent of their largess on the G.O.P.”
Yet it makes sense that the financial sector and those who already leaned Republican might object to Obama; they stand to lose the most in profits, but thanks to the financial reform legislation wending its way through the byzantine congressional process, those costs will end up in the accounts of shareholders.
First and foremost, mutual fund managers have recoiled at the legislation, not because it mentions them, but in fact because it leaves the possibility that they might be affected unexpectedly. Paul Stevens, head of the industry association, said that the legislation “could subject mutual funds to unworkable forms of bank-like regulation in the unlikely event that regulators deem a mutual fund [to be] a source of systemic risk.” Plus, as a consequence of the bill, the FDIC “would have the discretion to treat similarly situated creditors differently” when liquidating certain companies, meaning that mutual funds, the primary investment vehicle for most small investors, could potentially be given short shrift.
While most investors have nothing whatsoever to do with hedge funds, their managed investments and pension funds likely have at least some value that would now suffer from the increased cost of compliance with oversight. As the Wall Street Journal reported, “‘You have to pay a lot of lawyers,’ says Peter Kim, a 41-year-old registered commodity trading adviser in California…. ‘Disclosure is OK, but the SEC process is too much.’” Moreover, “the tone from examiners has shifted, too, with many exams seemingly more like investigations than the routine audits of years past, lawyers say. ‘The audit process has become a vehicle for altering behavior and enforcement. It's such a resource drain,’ says New York fund attorney Marco Masotti, whose clients include multibillion-dollar hedge funds registered with the SEC.” Shareholders can expect all of these new costs to take a bite out of profits before they even get passed along.
But there will be fewer profits to be had, even from blue-chip stocks free from the scandal. Given that Dodd’s bill affirms that the government will no longer help firms that are “too big to fail,” bond ratings companies like Moody’s and S&P will have no choice but to rate the corporate bonds from companies like Bank of America and General Electric as riskier investments. That change will lead to decrease in the values of the bonds, and it will saddle the companies with larger interest rates, which will push down the stock price as well. Citigroup asserted that a one-notch downgrade of its long-term bonds would add $1.2 billion in collateral and cash requirements, and the same downgrade of short-term debt would cut off access to approximately $14.4 billion in short-term funding sources.
Yet the true sources of ongoing risk in the market, holding over 96.5% of all new home loans last quarter, Freddie Mac and Fannie Mae, remain untouched by the bill. In short, risks for all fixed-income and equity holders go up, returns for investors go down, and the risks incurred by taxpayers by guaranteeing Freddie and Fannie remain as large as ever.
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