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Saturday, 06/26/2010 8:35:39 AM

Saturday, June 26, 2010 8:35:39 AM

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Rules May Hit Every Corner of JPMorgan
June 25, 2010

The J. P. Morgan & Company bank building in Manhattan in 1915.

Not since the Great Depression, when the mighty House of Morgan was cleaved in two, have Washington lawmakers rewritten the rules for Wall Street as extensively as they did on Friday.

And perhaps no institution better illustrates what would — and would not — change under this era’s regulatory overhaul than the figurative heir to that great banking dynasty, JPMorgan Chase & Company.

Unlike in the 1930s, the modern House of Morgan will remain standing. So will its cousin, Morgan Stanley, which broke off in 1935 after Congress placed a wall between humdrum commercial banking and riskier investment banking.

The proposed Dodd-Frank Act, worked out early on Friday morning, stops far short of its Depression-era forerunner. But in ways subtle and profound, it has the potential to change the way big banks like JPMorgan do business for years to come.

“It’s a tough bill, and shows the pendulum is swinging toward tighter regulation,” said Frederick Cannon, a banking analyst at Keefe, Bruyette & Woods in New York. “This is going to pressure bank earnings well into the future.”

Of course, all the big banks would feel some effect. Goldman Sachs, for example, would have to rein in its high-rolling traders. Wells Fargo would be subjected to stricter rules on consumer lending. And many large banks would feel the pinch of lower transaction fees on debit cards.

But JPMorgan Chase — forged by a merger of J. P. Morgan & Company with Chase Manhattan in 2001, after the wall came down between commercial and investment banking — and its chief executive, Jamie Dimon, will have to contend with all that and more.

It is the largest player in derivatives, the financial vehicles that have been widely faulted for adding excessive risk to the system. It runs the largest hedge fund in the banking industry, the $21 billon Highbridge Capital unit, and makes billions of dollars’ worth of trades in its own account. And it has a network of retail branches in nearly every corner of the country.

“Given its franchise diversity, JPM is impacted by virtually all of the coming regulatory reforms,” Keith Horowitz, an analyst at Citigroup who follows big banks like JPMorgan, wrote in a research note last week.

One part of the bill would push much of the buying and selling of derivatives onto clearinghouses, forcing banks to put up collateral against each trade. For JPMorgan, that could tie up billions of dollars that would otherwise have gone toward lending or the bank’s own trading.

A smaller portion of trading in derivatives would take place over exchanges, making prices visible to the public and pushing down prices — and profit margins.

Banks would be required to hold more capital in reserve to cover potential trading losses. In some cases they might also be prohibited from using federally insured bank deposits for risky trading. That would hit JPMorgan hard because of its heavy reliance on customer deposits to finance other businesses.

Both changes would take even more money out of play and lower profits.

JPMorgan has already begun dismantling its so-called proprietary trading operation, to comply with new restrictions on banks making speculative bets using their own capital. Analysts say that will force the bank to give up about 2 percent of its revenue.

Under the proposed bill, the bank would also have to be more careful about separating its money from the money it manages for clients in its private equity and hedge fund units, because of a rule to limit the amount banks can invest in such funds. Still, JPMorgan would be able to hang on to Highbridge and several other investment funds because of a special exemption.

It is more difficult to judge how the new rules could affect the Chase side of JPMorgan. A newly created consumer financial protection agency would have broad new authority over financial products like mortgages and credit cards, but it may be years before the agency issues new rules governing such products.

Recent legislation imposing new restrictions on credit cards and overdraft fees has already taken a bite out of bank revenue. The new legislation would add to that drain on revenue by restricting the fees banks can charge for debit card transactions.

In his research note, Mr. Horowitz estimated that the legislation would ultimately reduce the bank’s earnings by as much as 14 percent. That estimate could be cut in half or more because several of the most severe measures in the bill have since been dropped or diluted.

Of course, these assessments do not take into account all the steps that JPMorgan and other banks could take to mitigate the effect of the legislation, like passing on some costs to customers or seeking exemptions from regulatory agencies.

Indeed, JPMorgan could feel a greater effect from deliberations taking place at the United States Federal Reserve and among central bankers in Switzerland. Both sets of regulators are considering a requirement that banks hold additional capital as a cushion against losses. They also may alter the businesses the banks can invest in, or the regions where they can expand.

Indeed, Mr. Dimon has delayed raising the bank’s dividend until international rules are set on capital requirements.

Investors seemed to signal relief that the legislation did not turn out to be as tough as it might have been, sending the share prices of most major banks up about 3 percent on Friday.

Charles Geisst, a professor of finance at Manhattan College and a Wall Street historian, said the bill, which is expected to be signed by President Obama before the Fourth of July holiday, was the most comprehensive financial regulation since the Great Depression because it touched on so many different areas. But he said its effects would not be as fundamental as the impact of changes made in the wake of the Depression.

“It doesn’t go anywhere near,” he said. “It doesn’t change institutional behavior like that did. This is business as usual, with some moderation.”

"For when the One Great Scorer comes
To write against your name,
He marks-not that you won or lost-
But how you played the game."
-Grantland Rice

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