Bill Gross argues that tougher regulation of investment banks, particularly regarding leverage, will lower their profits. While his forecast is intuitively correct, it will also increase the propensity of professionals in non-capital-using businesses, like M&A amd fund management, to form boutiques or operate in pure-play firms subject to less oversight.
Goldman Sachs Group Inc., Lehman Brothers Holdings Inc. and Merrill Lynch & Co. will earn less and face higher borrowing costs because of increased regulation of investment banks, Pacific Investment Management Co.’s Bill Gross said.
Treasury Secretary Henry Paulson today proposed the broadest overhaul of U.S. financial regulation since the Great Depression and said the Federal Reserve should expand its oversight. The Fed earlier this month engineered New York-based JPMorgan Chase & Co.’s purchase of Bear Stearns Cos. and became the lender of last resort to the biggest bond dealers.
Investment banks’ invitation to borrow at the Fed’s discount window will “come with a price tag,” Gross wrote on Pimco’s Web site today. “There seems no way that current reserve requirements for banks will not in some nearly uniform way be imposed on investment banks. Leverage and gearing ratios of securities firms therefore, will in a few years resemble those of commercial banks themselves resulting in reduced profitability for major houses such as Goldman, Lehman and Merrill Lynch,” said Gross, who is based in Newport Beach, California. The three securities firms are all based in New York.
“These shadow banks will likely be forced to raise expensive capital and/or reduce the bottom line footings of their balance sheets,” Gross said. This “will be costly, and bond spreads as well as stock prices should begin to reflect it.”