Hedgeye

Our Dec 22 post entitled "Healthcare Reform as Case Study for Financial Reform?" (republished below) concluded that the money talks culture of Washington raises the probability that Financials will emerge more dinged than dented from what is being billed as the biggest regulatory overhaul since the Great Depression, but which we now call the "Toothless Tiger".

As a follow up to that post, there is an excellent Bloomberg story today entitled "Bankers Get $4 Trillion Gift From Barney Frank", in which David Reilly, who read cover to cover the 1,259 page House Financial Reform Bill (HR 4173), provides compelling evidence culled from the Bill itself suggesting that not only will the industry not be dented or even dinged; but rather, the Bill passed by the House could turn into the same positive catalyst for Financials that the Healthcare reform bill was for the HMO stocks. A few of the main takeaways are that the Bill authorizes Federal Reserve banks to provide as much as $4 trillion in emergency funding for the next Wall Street crisis (more than doubling the Fed’s commitment in this crisis). It would also allow the government, in a crisis, to back financial firms’ debts, and it contains a provision whereby, in the event of another government request for emergency aid to prop up the financial system, debate in Congress be limited to just 10 hours.

In other words, rather than teaching industry a lesson and limiting taxpayer commitment going forward, the House of Representatives just passed a bill that would make such future bailouts a guaranteed-by-law, fully-automated process. It's no wonder why banks are returning to risk - every financial institution now has an added incentive to do so, pushing earnings higher while adding to systemic risk at the same time.

While there are still items of punitive substance in the Bill, we would expect the full power of the Financial Industry lobby to chip away at those over the next few months rendering the Bill largely toothless by the time it become law.

Previously published (12/22/09):

2009 was the year of Healthcare reform, and 2010 will be the year of Financial reform. One of the most consensus calls I know of right now is that 2010 will be a train wreck for financial companies on the regulatory and legislative front. This has been my position, and when I suggest this idea to investors, I receive no pushback at all, just unqualified agreement. This is disconcerting. It means there’s a herd mentality on this issue, and I never like to be in the middle of the herd because the herd is often wrong. What is everyone missing on financial reform? Watching the evolution of the healthcare reform process over the past year shed some new light on the matter.

Comparing the two sectors, Healthcare and Financials, one can't help but notice the similarities in their respective legislative reform processes. They are both large, influential industries with major Washington clout that have been targeted for reform by the Administration. At the end of the day, meaningful healthcare reform (i.e. a public plan option) broke down for several reasons, but I believe mainly because the Healthcare lobby was just too powerful for the White House to overcome. Simply put, Congress gets too much money from the Healthcare industry for it to really shake things up.

With this in mind, I thought it would be worthwhile to look at how the Healthcare industry compares with the Financial industry from the standpoint of political contributions. The following chart sums it up. From 2006-present, the Healthcare industry contributed 12% ($308 million) of all political contributions making it a major player, but still only the third largest industry contributor. The Financial industry contributed 32% ($821 million) of all political contributions, or roughly 2.7x what the Healthcare industry contributed, making it far and away the largest (and therefore most influential) industry. Case in point, most people don't realize that Goldman Sachs was President Obama's single largest private campaign contributor. If money talks, as the Healthcare reform process suggests, Congress will be listening carefully to the Financial industry's pushback as "reform" gets going in 2010.

Health Insurers were at the bullseye of President Obama's plans for Healthcare reform, but roughly 10 months after promising to shake things up (i.e. lower the profitability of HMOs) Health Insurer stocks are trading at 52 week highs, and the Healthcare sector is the best performing sector within the S&P over the last three months so clearly there was a breakdown between the rhetoric and the reality.

Why is the Healthcare sector outperforming in the face of the first comprehensive healthcare overhaul in decades? At the risk of being overly simplistic, the White House outsourced the details of its reform agenda to Congress, and Congress refused to pushback against the powerful healthcare lobby when they offered much-needed 2010 campaign support in exchange for pulling the teeth out of the bill. The following chart chronicles the evolution of the healthcare reform debate plotted against the performance of the HMO index. Now that we have a case study for how this Administration and Congress execute major industry "reform", we have a roadmap for Financial reform.

We would submit that 2010 for Financial stocks could look a lot like 2009 for Healthcare stocks. This doesn't bode well for the beginning of the year, but there could be light at the end of the tunnel. The year will likely start out with a lot of jawboning from Congress and the Administration: pitting fat-cat bankers against the general public. This could lead the sector to an inauspicious start to the new year, just as Healthcare began 2009. But as the year progresses, we would expect to see the Financial lobby slowly pull the teeth out of the reform agenda. $821 million in contributions buys a lot of pliers, which is why we'll be keeping a close eye next year not on what politicians say about financial reform, but on what they do.

Joshua Steiner, CFA
203.562.6500
jsteiner@researchedgellc.com