Federal Reserve Limits Bank Deals to Avoid Another Bailout

A major problem in 2008 was the fact that we had large banking institutions with big balance sheets and the Federal Reserve response was to save these institutions via taxpayer bailout. This is where the term “too big to fail” comes from. Over four years later, Chairman Ben Bernanke is now telling certain financial institutions that they are “too big” and that they must limit their acquisitions to very small deals. This announcement comes just as the debate on risky lending reemerges in Washington.

The Federal Reserve told Capital One (NYSE:COF) earlier this year not to engage in any more high profile deals after the financial institution paid $9 billion to acquire ING Grorp N.V. (NYSE:ING). Similarly, a number of US banks stop pursuing Bank of America’s (NYSE:BAC) non-US wealth management business after consulting with the Federal Reserve. Keep in mind that these warnings are a new power that the Federal Reserve acquired through the 2010 Dodd-Frank Wall Street law.

Another new banking law from the Dodd-Frank law states that a US bank can not buy a competitor if the acquiring bank holds at least 10% of all US deposits. This prevents banks from buying up rivals and essentially creating a “too big to fail” scenario. Unfortunately, while this new rule is designed to save Wall Street and the US from another 2008, it could have an effect on the economy as well.

When the government limits deals that are occurring in the marketplace, this is less money that cycles through our economy. This could be harmful now in particular as our economic recovery continues to stall and proceed at a snail’s pace. The point I am trying to make is that this new power by the Fed does not give banks any confidence, not that they have had any the last four years. Banks already are reluctant to give loans in this environment; in addition to the continued decline of hiring new employees.

The bottom line here is that while we need to take steps to prevent a “too big to fail” scenario from happening again, I think it is important to help promote growth and confidence particularly in this environment. Banks continue to show some anxieties as the recovery continues at a slow pace and the potential consequences of the Fiscal Cliff. Congress and President Obama continue to debate on the subject but much like the debt ceiling talks, it appears that no progress is being made.

Could we once again see the US government kick the can down the road in the 11th hour?

All I know is that if we do go over the cliff, we could easily jump right back into a recession. Pundits have all highlighted the “automatic” increases should we go over the cliff but one must ask if our credit rating will be once again on the chopping block? Rating agencies have continued to warn the US government that our credit rating could be at risk for another downgrade should the budget talks continue to make no progress.

In the end, there is a lot of uncertainty in markets right now and the best thing that investors can do is to hedge positions and being prepared for any significant downside in the coming weeks.

Disclosure: None