It is an interesting time for bank stocks. In the aftermath of two federal regulatory actions last week, the money-center banks are becoming more public than private institutions.
First the good news. Federal banking regulators announced that they are relaxing provisions of the Volcker Rule, which was an important part of the Dodd-Frank Act of 2010. Readers might recall that act was passed in the aftermath of the financial crisis. It was meant to prevent another "too big to fail" scenario within the nation's banking system.
A key provision of the act prevented banks from using their own funds to invest in risky assets such as derivatives, options, private equity, and hedge funds. Those rules have been essentially relaxed, allowing large banks a wider latitude in what they can invest in. Margin requirements (at least in some areas) such as in swap trades, have also been eased.
The long and short of it is that banks have been allowed to once again travel the road of riskier investments. The lowering of margin requirements will also free up $40 billion in capital that banks can now use in proprietary trading. This turn of events might be troubling to those of us who remember the worst crisis since the Great Depression in this country.
But what Big Brother giveth, he can also take away. Last Thursday, the Federal Reserve Bank released the results of its annual stress test of the 34 largest banks in the U.S. Stress tests are another regulatory change that was implemented by the federal government as a result of the financial crisis. They are meant to ensure that the United States banking system can withstand shocks to its capital base.
The COVID-19 pandemic and its impact was the focal point of the regulatory authorities test this year. All 34 banks passed the minimum capital requirements necessary under these circumstances, although in the worst-case scenario regulators said "several would approach minimum capital levels."
That's the good news. The bad news was the Fed also ordered the banks to limit shareholder payouts and suspend repurchases of their stocks during the third quarter. Dividend distributions will be limited to the levels banks paid out in the second quarter.
While the news initially surprised investors, banking stocks have gained ground since the announcements. That should not surprise you, given the steady encroachment by the Federal Reserve Bank and the U.S. Treasury into the private sector since the beginning of the pandemic. The fact that banks have increasingly operated under the thumb of government has been going on for the last decade. It is one explanation for why the sector as a whole has consistently underperformed other areas of the stock market.
One might question where and when will this creeping nationalization of the private sector economy come to an end. The Fed is already purchasing bonds from companies such as Verizon on the open market as well as bond funds and exchange traded funds. Will stocks be next?
Today, the government announced a $700 million loan to a major trucking company, YRC Worldwide Inc., in exchange for an equity stake of 29.6 percent. In the name of the great pandemic, as companies become increasingly distressed, I believe more and more of the economy will come under the control of the government. The question to ask is then what?
As I have maintained, I fear we are fast transforming from a quasi-capitalistic economy into something that resembles Europe's economic socialism, or even China's centralized economy. It appears we have no say in the matter. Is it that our free market system has become an antiquated idea and has no place in today's global economy? That is for you to decide.
Bill Schmick is now the 'Retired Investor.' After working in the financial services business for more than 40 years, Bill is paring back and focusing exclusively on writing about the financial markets, the needs of retired investors like himself, and how to make your last 30 years of your life your absolute best. You can reach him at email@example.com or leave a message at 413-347-2401.
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