The Volcker Effect

 | Dec 10, 2013 | 11:08 AM EST
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Where would JPMorgan Chase's (JPM) stock be if the Volcker rule had been a reality a few years ago? I would say probably at $65, almost 10 points higher. Where would Goldman Sachs (GS) shares be? Maybe as high as $200, up 30 and change.

It's hard to understand how wrong the media has been on Volcker. We think that Volcker is some sort of Manchurian Candidate -- a government-embedded destruction machine for U.S. banks. But in this version of the Manchurian Candidate, Frank Sinatra, aka Ben Marco, tries to pull all the wiring out of the Manchurian Candidate's head but fails, and the banks' earnings are met with doom. That version, like the movie, is fiction.

Sure, the banks fought tooth and nail. What are they going to do? There are more compliance costs, and anyone who works at one of these banks knows that compliance is a deadweight loss.

How does it affect earnings? Let's just say it will not affect earnings beyond, maybe, a penny per share as the legal infrastructure is set up to comply, and that's already been taken.

The biggest windfall, however, will be to the banks' price-to-earnings multiple. I believe this rule could send it higher, maybe dramatically. Why? Because the single biggest price-to-earnings dampener for banks after the Great Recession is what happened to JPMorgan with the "London whale" incident, a terrible lack of oversight that cost the stock about a third of its value.

Further, investors decided that this group is filled with unregulated gunslingers who aren't reined in by anyone, because if the gunslingers make billions in prop trading, then the bonuses will be fabulous. And if they lose a ton, they won't lose their jobs -- they can blame the direction of the market, but the shareholders get clobbered.

Those who play the whale get hunted like Moby Dick, and the Ahabs are the CEOs who know they will lose their jobs or, perhaps, be prosecuted under a loose interpretation of the law. That's a very big change.

I believe we will now presume that there is less rogue behavior and begin to value these stocks like companies with steady income streams. And their values will increase, perhaps dramatically, as was the case with Morgan Stanley (MS), which rallied 60% on the welcome news that it had become Volcker-compliant with gusto.

If you doubt me on this, consider the rally in the regional banks and, more important, the non-bank financials, where a lot of money went because of concerns that they could be in banks that blew themselves up prop trading. Plus, no one was ever going to put a multiple in prop-trading profits because of the double-whammy of inconsistency of the earnings streams and the possibility of whale-like chicanery.

Why so much focus? Why so many articles about how this is a major defeat for the banks?

First, banks fight regulation. Any regulation. That's what they have to do. Second, the media doesn't focus on the boring, prosaic earnings or the equally boring, prosaic process of figuring the P/E multiple -- what we will pay for those earnings.

The earnings stream is now indelible. The business is much easier to understand, thanks to Paul Volcker and his merry band of Congress members.

Thanks for driving the prices of bank stocks up, Washington. Why couldn't you have passed this legislation two years earlier? Who knows how the bank index might be.



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