The Sum of All Fears

So America’s financial reform bill has moved a step closer to becoming law, with the Senate version getting the necessary votes late on May 20th. Now begins the conference process of reconciling the House and Senate bills, which have significant differences – a classic smoke-filled-room activity that always has the potential for surprises, often of the nasty variety.

We will write about what we think of the various aspects of the likely legislation in future posts. For now, suffice it to say that the Titans of Wall Street seem fairly relaxed about what now seems likely to emerge from the Washington legislative sausage factory. “You may accuse me of being too relaxed,” the head of one big Wall Street bank confided at an off the record lunch yesterday, “but we will adapt. We may have to spin off our real-estate and private-equity businesses, and a few others. But we will adapt and move forward. There are plenty of opportunities.”

So, what does keep him awake at night? Two things. First, that the ratings agencies will downgrade his and other Wall Street banks. Why might they do that? To summarise: They are not a very talented bunch, as their performance during the real-estate bubble demonstrated. The US government has been talking about how no bank is too big to fail, which literal-minded people at the ratings agencies might take seriously, especially if the current nervousness in the markets continues – even though everyone knows this talk is just political posturing and, in reality, after the fright letting Lehman Brothers fail caused, there is no way any systemically important financial institution will be allowed to go bust in the forseeable future.

Second, although he stresses that his bank is now extremely well capitalised, he worries that the world’s central banks will gang together through the Bank for International Settlements in Basel, to impose excessively tough capital requirements. Our talkative bank boss does not fancy having to initiate another capital raising campaign, particularly given the current market conditions.

He is not the only Wall Street Titan to worry about the potential for risk-averse cental banks to damage the wealth creation process by imposing heavy capital requirements on banks under the “Basel 3″ process now under way. The head of a big private-equity firm recently confided that he saw this as a far more likely, and serious, danger than any regulatory reform likely to emerge from Congress – especially because central bankers now represent the nearest thing the developed world has to unchecked, unaccountable political and economic power. Is this just scaremongering by wealthy financiers? Watch this space!

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