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By Alistair Barr, MarketWatch

SAN FRANCISCO (MarketWatch) — Financial reforms finalized this week may trigger a “jarring shake-up” of the industry, forcing some of the largest companies to change how and where they do business in a bid to preserve profits, analysts say.

Parts of the legislation that could have the biggest impact include derivatives reform, limits on proprietary trading and a potentially potent, new consumer-finance watchdog.

“This giant conglomeration of restrictions will be loaded onto an industry that’s still struggling to adjust to losses from the financial crisis,” said Joseph Mason of Louisiana State University, an expert on financial crises.

The new rules represent the biggest regulatory changes for banks and brokers since the Glass-Steagall Act was introduced after the Great Depression. Some say it may have an even bigger impact.

Glass-Steagall, repealed in 1999, was considered an onerous regulation that forced the separation of securities and commercial banking. But it didn’t actually impose much change. J.P. Morgan split up in the wake of the law, but it wasn’t forced to take that step, Mason noted. The regulations that have crystallized in Congress in recent weeks could fuel much bigger changes, he said.

Congress still needs to vote on the final version of the legislation, but President Barack Obama is expected to sign it into law by July 4.
Read more about the political process.

Doubt cast

“The scope and depth of the legislation appear far more negative than we had anticipated following the Senate version passed in May,” wrote Todd Hagerman, a banking analyst at Collins Stewart, in a note to investors Friday. “Both industry and economic growth will likely be suppressed for an extended period as banks continue to deleverage and develop a more thorough understanding of the broad-based structural changes likely to affect the industry in the coming years.”

The legislation could have been worse: The outright ban of some capital-markets businesses, the breakup of systemically important companies and specific, strict capital requirements were avoided. However, the new law casts doubt on the financial industry’s growth prospects and its ability to restore profits to more normal levels, according to Hagerman.

“Financial supermarkets” like Bank of America Corp.
/quotes/comstock/13*!bac/quotes/nls/bac
(BAC
15.42,
+0.40,
+2.66%)
, Citigroup Inc.
/quotes/comstock/13*!c/quotes/nls/c
(C
3.94,
+0.16,
+4.23%)
, J.P. Morgan Chase & Co.
/quotes/comstock/13*!jpm/quotes/nls/jpm
(JPM
39.44,
+1.41,
+3.71%)
and Wells Fargo & Co.
/quotes/comstock/13*!wfc/quotes/nls/wfc
(WFC
27.05,
+0.19,
+0.71%)
will be hit the hardest, the analyst said.

Hagerman and other observers said the legislation probably won’t force big banks to raise new capital, but it could tie up spare money that some investors were hoping would be used for share buybacks and dividends.

New limits on big banks’ derivatives businesses may soak up the most capital, some analysts commented.

“Given that many banks appear to be overcapitalized when looking at normalized levels of loans and assets, this may result in less excess capital available for buybacks and dividends, rather than requiring another round of capital raising,” Chris Spahr, a banking analyst at CLSA Asia-Pacific Markets, wrote to clients Friday.

Shift abroad

Some of the largest banks may shift their focus overseas in search of growth, according to CreditSights, an independent fixed-income research firm that described the new regulations as a “jarring shake-up to the banks’ profits model.”

Earlier this week, J.P. Morgan appointed executive Heidi Miller to a newly created post of international president. She’s charged with building the firm’s global business lines and pursuing opportunities in emerging markets.

The current blockbuster fixed-income trading cycle ‘may prove to be the last hurrah of the trading culture of Wall Street.’

Mark Hintz, Bernstein Research

Such moves suggest that new financial regulations will make U.S., consumer-focused banking less attractive as returns won’t be high enough to justify the cost of the extra capital required to support such businesses, CreditSights wrote in a note.

Institutions with large bank-branch networks will likely scale back a lot and sell assets, CreditSights predicted. This is a big change for the U.S. financial-services industry, which has focused on expanding branch networks for the past two decades, the firm said.

This may be particularly tricky for J.P. Morgan, CreditSights said. The financial-services giant emerged from the financial crisis relatively unscathed, but also took on a huge network of bank branches from its acquisition of failed thrift Washington Mutual
/quotes/comstock/11i!wamuq
(WAMUQ
0.18,
+0.01,
+6.81%)
.

‘Scalps’

A new Consumer Financial Protection Agency, or CFPA, will oversee products like mortgages and credit cards, further diminishing the allure of such businesses for big banks in the United States.

The CFPA will be part of the Federal Reserve, which is seen as a pro-bank regulator. However, the agency could be “tremendously disruptive” depending on who is appointed to run it, according to LSU’s Mason.

Big banks face ‘jarring shake-up’ from new rules

By Nick Godt, MarketWatch

NEW YORK (MarketWatch) — In the 1947 classic novel “The Plague” by Albert Camus, a deadly epidemic shuts the town of Oran in Algeria from the outside world and leads to panic, a near collapse of institutions, order, common sense and humanity.

Ultimately, two leading and opposing trends emerge on how to respond with the issue and to sway the course of action.

On the one hand, religious and repressive judicial authorities say the plague was a long-coming, well-deserved punishment from God for the sins of the populace and the breakdown of values.

On the other side is the scientific and medical community, which tries to relieve human suffering while seeking and ultimately finding a cure. The human toll, however, has been devastating — in large part due to human folly in opposing relief efforts.

In the same vein, as leaders of the Group of 20 nations meet in Toronto this weekend, we’ll all be reminded why the outlook for jobs and global growth as well as for markets is getting darker by the minute.

Unlike two years ago, when global leaders were united in their will to stimulate economies and avoid the abyss of another Great Depression, this time around, members of the “order for a new age of austerity,” it seems, will outnumber the proponents of stimulus, job creation and growth.

The order has found new high priests in the leaders of Germany and the United Kingdom, who say that we must accept the painful penance of cost-cutting measures now to appease the gods of market forces. Debt markets must be dealt with at all costs, as must the guilt of passing on debt to future generations.

The simple idea that the outlook for long-term deficits magically improves when employment and economies grow, which boosts government revenues via already existing taxes, is apparently lost on anyone whose desire for repentance overwhelms everything else.

The real-world result: The growth outlook for Europe has been severely hit, not because of the debt crisis itself, but because of the austerity measures.

It could be said that part of the 14% correction in U.S. stocks from late April through early June accounted for part of this. This week, the Federal Reserve did acknowledge that there will be a hit to U.S. growth.

At the same time, the impact of stimulus measures in America — measures that were implemented at levels much less than advocated by many prominent, nonprivate-sector economists — is quickly fading.

Huge drops in home sales this week and a downward revision in first-quarter growth might serve as reminders that in fact, not enough stimulus was put into the economy. China, which spent 10 times more relative to the size of its economy, is now busy slowing down its growth.

Yet U.S. members of the order point to the fading effect of measures that were too small to begin with as proof that the really reasonable thing to do is inflict pain by cutting spending.

Nowhere was this more evident than in the punitive move by Congress this week to not renew the spending bill to extend the period of unemployment benefits: About 2 million Americans will lose their benefits by the end of July, including 1.3 million by the end of this week.

Huge drops in home sales this week and a downward revision in first-quarter growth might serve as reminders that in fact, not enough stimulus was put into the economy.

As Sal Guatieri, senior economist at BMO Capital Markets, said in a note: “This is another body blow to consumer spending, which is already flagging.”

Legislators’ punitive side, meanwhile, didn’t seem to impress Wall Street on Friday following what has been called the biggest overhaul of the financial system since the Great Depression. Banks and financial stocks rallied, with Goldman Sachs Group Inc.
/quotes/comstock/13*!gs/quotes/nls/gs
(GS
139.66,
+4.68,
+3.47%)
shares up 3.5%, J.P. Morgan Chase & Co.
/quotes/comstock/13*!jpm/quotes/nls/jpm
(JPM
39.44,
+1.41,
+3.71%)
up 3.7%, Bank of America Corp.
/quotes/comstock/13*!bac/quotes/nls/bac
(BAC
15.42,
+0.40,
+2.66%)
up 2.7% and Morgan Stanley
/quotes/comstock/13*!ms/quotes/nls/ms
(MS
25.01,
+0.75,
+3.09%)
up 3%.

But the order likely will say that private-sector firms are about to unleash a big wad of cash that will make up for the lack of consumer and government spending, hiring massively in the face of a darkening global economic outlook.

For some reason, however, firms flush with cash after the bursting of the tech bubble didn’t really begin spending or hiring until after the housing bubble lifted the economy out of recession (as most reasonable businesses usually do).

The order’s faith in market forces might be strong, but the market itself didn’t seem to be holding its breath about growth this past week, which saw stocks slump for the first week in three due to worries about the economy.

The Dow Jones Industrial Average
/quotes/comstock/10w!i:dji/delayed
(DJIA
10,144,
-8.99,
-0.09%)
fell 2.9% points, while both the S&P 500 Index
/quotes/comstock/21z!i1:inx
(SPX
1,077,
+3.07,
+0.29%)
and the Nasdaq Composite
/quotes/comstock/10y!i:comp
(COMP
2,223,
+6.06,
+0.27%)
slumped 3.7%.

Nick Godt is MarketWatch’s markets editor, based in New York.

Nick Godt’s Market Medics: Stocks sense the plague is coming (back)