Financial Reform Bill Encourages Risk-Taking

As the details of the agreement struck by the key House and Senate conference on financial reform has been embraced favorably by the US equity market, that is being led by the financials, and the foreign currencies.

In the past three months the major foreign currencies, like the euro, sterling, yen, and the Canadian and Australian dollars are more than 50% correlated with XLF, which is the Financial Select Sector exchange traded fund.

No doubt the US delegation to the weekend G20 meeting will be proud of this achievement and puts the US ahead of Europe, it would appear, in financial reform. However, a preliminary reading of the reforms suggest there is probably less than meets the eye. Three important points stand out.

First, rather than ban certain activity like prop trading, or investment in hedge funds or private equity firms, it will be limited.

Second, the bill does not appear to break up the "too big to fail" institutions.

Third, some banks will have to boost their capital, but appear to be given several years to do so.

European officials are unlikely to be very happy with the US bill, which still needs to be voted on by the entire Congress. The lack of international coordination risks "regulatory arbitrage". Several European countries seemed much more committed to the idea that if it is too big to fail, the institution is too big.

Separately, note that the new Basel Accords are expected toward the end of the year and will further carve out new capital requirements.