By Nick Rice for FundStrategy
The phrase “elephant in the room” could have been invented for financial institutions that are deemed too big to fail. Although the financial crisis trumpeted their existence and their potentially uncontrollable effect on the economy, the American financial reform bill failed to make them much smaller. One of the most outspoken critics of the proposals is Bill Isaac, who headed the Federal Deposit Insurance Corporation (FDIC) in the early 1980s and helped handle a ferocious banking crisis.
Isaac attacked the American government’s response to the financial crisis in 2008, saying it could have averted panic in advance by guaranteeing critical areas of the system.
He describes the Dodd-Frank financial reform bill as “a campaign document” in advance of congressional elections this year and says there is no certainty any of the problems facing the sector will be addressed, let alone too-big-to-fail.
As the former FDIC head points out, plans to split commercial and investment banking firms do not match the breadth or transparency of the Glass- Steagall Act of 1933.
Whereas Glass-Steagall made banks more manageable and comprehensible, splitting the two sectors in a bill of less than 50 pages, Dodd-Frank takes more than 2,000 pages to achieve something more complicated but less radical.
Nor has the American government downsized too big to fail firms outright, Isaac observes. Lawmakers have announced no new size caps for the five largest banks, which account for more than half of American lending, nor for Freddie Mac and Fannie Mae or the toobig-to-fail insurers.
Tom Walker, the manager of the Martin Currie North American fund, one of the largest domiciled in Britain, argues regulators may hold back on scaling down individual institutions until they return to full financial health.
He is cautious on the sector pending further regulation, which Isaac says is possible after the elections, provided voters elect “a lot of new people who were not part of creating this crisis”.
Walker’s fifth largest active underweight position at the end of June was in Bank of America, although he held a significant overweight in JPMorgan Chase, at 3.8% against 1.4% for the fund’s MSCI North America index.
At 11.8%, his weighting in financials was well below the index, where it was 17.2%, according to Martin Currie Investment Management.
Banks may be resisting the elimination of too-big-to-fail, on the grounds they are reluctant to see their powers reduced and some of their services require economies of scale.
But to satisfy all their potential investors, Walker included, banks mayhave to follow Isaac’s route to reform.
Original Article Located Here.