Paying for the Bailouts

Story Highlights:

• Even as the global financial system stabilizes, onerous regulations and political scrutiny in the US and abroad continue to impede Financials' complete recovery.
• Politicians globally agree more regulation and assurances are needed, but there is disagreement on the exact steps to take.
• Financials' woes won't hold back economic recovery, but stocks in the sector face uncertain regulatory headwinds.

Last year around this time, panic was plunging Financials into fearful depths. A number of sizeable firms had gone bust, assets were being written down, credit markets were largely frozen, and many feared widespread bank nationalization was unavoidable. The vast majority survived the tumult, but now face whole new challenges. Even as the global financial system stabilizes, onerous regulations and political scrutiny in the US and abroad risk impeding Financials' complete recovery.

Regulators and governments around the world are doing their best to get their "pound of flesh" from bailed-out banks. US financial regulators are imposing compensation limits, considering requiring large firms to contribute to a bailout fund, and addressing "too big to fail" issues—which could someday force the break-up of the largest institutions. Last week, the House voted to freeze credit card interest rates, fees, and repayment terms for nine months as part of a larger bill targeting credit card issuers. If passed by the Senate (which is delaying its vote until next year), this amendment could potentially weigh on banks' profitability and inhibit risk management. 

Regulatory actions abroad are even more severe. Recently, the UK's Royal Bank of Scotland and Lloyd's Banking Group agreed to scrap bonuses for employees making more than £39,000 in exchange for additional bailout funds. Both banks also agreed to sell branches and divisions to comply with bailout rules. The European Union also forced its banks to divest assets if they received government aid, with the amorphous goal of preventing "unfair advantages." Additionally, UK Prime Minister Gordon Brown called for additional measures to "fix" the financial system at the G-20 summit, including imposing a so-called "Tobin tax," which would tax every financial transaction, and new bank fees to pay for future bailouts.

Many proposed policies make it seem politicians are more intent on regulating, limiting, and punishing Financials than healing them. Excessive restraints could inhibit Financials' recovery and possibly impede more robust economic growth. Perhaps the uncertain economic impact of regulatory measures is why there's been more political posturing than actual policy implementation. Even though politicians and regulators globally agree Financials' risk-taking should be checked and more should be done to prepare for future crises, there is disagreement over the exact steps to take. These disagreements could delay policy—a positive for stocks overall but not Financials shares, which could struggle with drawn-out regulatory uncertainty. 

But banks' woes shouldn't hold back economic recovery. With the financial system now awash in cash thanks to massive amounts of monetary stimulus, the worst is likely behind us. This has helped ease credit markets and would normally be a positive environment for Financials' shares—if they didn't face such huge regulatory threats. Whatever form regulatory proposals finally take, there's a risk they'll undermine banks' abilities to produce profits, assess risk, and run operations. Or they could force additional share sales to raise capital, diluting existing shareholders in the process. Additionally, regulations that bend free markets tend to produce unintended, negative consequences. Case in point, credit card companies recently raised rates and introduced new fees in response to new federal regulations inhibiting them from making these changes in the future.

Governments' exacting demands on bailout recipients won't make for the smoothest Financials recovery. Ultimately, paying back the bailout will assuredly cost banks more than just the borrowed funds.