Location: New York
Author: Ken Silverstein
Date: Tuesday, April 27, 2010
Big banks may get reined in. But will that harm the utility sector, which benefits from the capital that those lenders bring?
Congress is now considering legislation to ban those financial institutions from participating in speculative activities that are not tied to the basic and federal-backed services that they offer. So, those investment banks that trade commodities for their own advantage so as to increase their revenues would be barred from doing so. But those that trade on behalf of their industrial clients would be allowed to continue.
The concern is that energy markets would be adversely affected by that legislation, now espoused by former Fed Chair Paul Volker who is a key presidential advisor. While the aim of the restrictions would be to curtail the types of risky banking practices that led to the worst recession in decades, some observers think it would also limit banks' abilities to liquefy energy markets. That would make it more difficult for utilities to perform risk management and to raise capital for projects.
While the kinds of reform pushed by the so-called Volker Rule passed the House in December, a similar measure is now stuck in the Senate. However, the Securities and Exchange Commission's fraud allegations against Goldman Sachs could serve to rally the American people and push the measure forward.
If it does, some are advocating precaution. Morgan Stanley has written a research report that says that banks could suffer anywhere from a 1 percent drop in revenues to an 8 percent fall: RBS would fare best at 1 percent while Deutsche Bank would feel an 8 percent hit. In separate testimony to Congress, Goldman Sachs says that its revenues would suffer by as much as 10 percent. The eight biggest banks would see profits fall by $11 billion, Morgan Stanley adds.
After the fall of Enron and other legacy trading firms, the big banks and separately-owned hedge funds provided the liquidity to utilities and other industrial concerns so that they could guard against price volatility. Most recently, J.P. Morgan has made a $1.7 billion stab at the European and Asian sections of the energy commodity business now owned by RBS and Sempra.
However, the investment banks, the bank-owned hedge funds and the independent hedge funds are under scrutiny. While the banks are contesting some of the proposed new rules, the hedge funds appear to have worked out what they call a reasonable resolution to regulatory concerns over the potential for market power abuses.
"Ironically, the energy markets may end up being pounded by a piece of legislation that is actually intended to limit 'bad behaviors' that have little or nothing to do with energy," says Patrick Reames, an analyst with UtiliPoint International, in story run by Commodities Now.
Reckless Activities
President Obama laid out his thoughts in a speech, expressing that banks were allowed to stray too far afield from their central mission of serving customers. Their implicit backing from taxpayers, he says, has permitted them to take unfounded risks. The institutions, in turn, get the huge rewards without suffering any of the pitfalls of failure.
"We simply cannot accept a system in which hedge funds or private equity firms inside banks can place huge, risky bets that are subsidized by taxpayers and that could pose a conflict of interest," Obama says. "And we cannot accept a system in which shareholders make money on these operations if the bank wins but taxpayers foot the bill if the bank loses." It's a view generally held by five previous treasury secretaries, who note that the implicit backing of taxpayers allows those lenders to take excessive risks.
The goal is then to inspire innovation while discouraging reckless activities. Even former Fed Vice Chair Alan Blinder says it is more of an art than a science. Writing in the Wall Street Journal, he notes that the task of separating proprietary trading from trading on behalf of customers is not that simple.
Perhaps the middle ground is not a blanket prohibition against proprietary activities but one that is performed on a case-by-case basis, says the Financial Services Roundtable. It advocates striking a balance between regulation and market innovation -- similar to the kind reached by autonomous hedge funds and their regulators.
Certainly, trading is a time-honored approach to hedging against price fluctuation. As long as wholesale markets for both power and gas are open, companies will still need to mitigate risks and there will always be a need to match buyers and sellers. Some entity will be required to aggregate the energy and to schedule its delivery.
Lawmakers must draw distinctions between banks trading on their behalf and that of their customers. Because those features are often blurred, the task is to somehow "disassemble" troubled institutions that have long been considered "too big to fail."
Skepticism now abounds. Consumer and investor confidence are paramount, but so is the remaking of the investment banking world that has provided critical liquidity and financing to utilities and others. And while the banking industry has been roundly criticized for its lobbying techniques, some in the sector are now arguing for more restraints or more "compartmentalization" of their activities.
The electricity and natural gas trading evolution will continue. Investment banks will stay involved, but they will seek partners. They will combine their knowledge of financial markets and hedging instruments with the capital and know-how provided by other entities that want a piece of the action. Risks must still be managed, which requires buyers and sellers of power and gas to lock in prices.
Big banks are unsympathetic institutions. But Congress should not severely impede their energy trading arms that have kept the utility sector flush with capital.
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