Wall Street could go back in time

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Wall Street regulation may soon get a lot more expensive.

In his weekly "Greed and Fear" newsletter, out Thursday, CLSA's Christopher Wood wrote on recent commentary from Federal Reserve governors Daniel Tarullo and Jerome Powell, who said the big banks may have to bolster their balance sheets to prevent possible shocks.

It could mean that the banks that pose the biggest risks to the overall financial system would need to maintain even more equity to pass their stress tests.

Already, the Fed's stress tests cost banks up to $400 million every year, Wood said.

He argued that if regulation intensifies, even as the Fed expects banks to remain healthy enough to avoid a systemwide financial crash, it may be logical to bring back an act that was repealed over a decade ago.

The Glass-Steagall Act, passed in 1933 and repealed in 1999, prohibited commercial banks from simultaneously engaging in investment banking.

"Such deregulation only makes sense if banks are allowed to fail, or at least bank bond holders are forced to lose money," Wood said.

He added:

As it is clear that the current conventional wisdom of the Davos mob remains against allowing capitalism to work in banking, it follows logically that the business of deposit taking should be separated completely from “investment banking” using the term in its broadest sense, in what would amount to the re-enactment of a modern Glass Steagall.

But rather than taking that simple but fundamental step, the regulators keep adding on more and more rules when the only beneficiaries are the rising number of employees in the compliance compartment and the related apparatchiks processing “stress tests."

One point is clear. The more dysfunctional these larger financial organizations become, the more likely that there will be a return to that old model in financial services before “Big Bang.” That was the private partnership where partners’ capital was at risk.

Wood isn't going as far as arguing that the big banks should be broken up. As Powell said, the aim of the proposal is to raise capital requirements to the point where banks themselves ask the question of whether they are too big.

What Wood sees is a contradiction between more expensive regulation and the expectation that commercial banks should be freely engaged in volatile financial markets.

The Wall Street Journal noted that the capital-requirement change may be proposed later this year and likely won't kick in before 2018. But banks would have to start making the adjustments before then.

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