BUSINESS
05/25/2010 09:08 am ET Updated May 25, 2011

Goldman Sachs: Lincoln's Derivatives Proposal Likely Won't Pass

Buried in a research report released yesterday on the growth potential of equities in the U.S. financial services industry, Goldman Sachs offered a glimpse into what the final version of the Wall Street reform bill might look like. (Hat tip to Morning Money.)

In particular, the report predicts that the Senate bill's most controversial element won't make it through the conference committee negotiation process. Sen. Blanche Lincoln (D-Ark.) proposed a measure that would require the nation's largest banks to spin off their derivatives desks, a move that initially passed with GOP support.

Though the spin-off requirement could cost banks billions annually, Goldman isn't at all convinced it will pass. From the Goldman Sachs report:

"...while regulatory risk is (hopefully) reaching a peak it does create the specter of an overhang for some time. In particular our Washington analyst does not expect the Lincoln proposal to make it into the final version of the bill, but should this occur it would be very negative for investment banks and potentially exchanges as volumes would suffer.

Lincoln's derivatives language is also getting targeted by some Democrats. Bloomberg reports that Rep. Mike McMahon (D-NY) has come out against the provision:

My position is that it should come out now," McMahon, one of the lead derivatives negotiators for the self-described "moderate, pro-growth" New Democrat Coalition, said in a telephone interview yesterday. "The House bill is based on principles on how to reduce risk and make the system more transparent, it's not based on wiping out the system or destroying the system and that's what the provision does.

As for Goldman Sachs's earnings outlook for the financial industry, the bank predicts that the industry will continue to post strong earnings per share and return on equity. The financial reform bill, the report, suggests may actually provide real benefits in bank earnings through consolidation. Here's more from the report:

Our normalized EPS estimates adjusted for potential regulatory impact implies that large banks can still generate a return on tangible common equity of 21% which is equivalent to a ROE of 13%. This compares to an average ROE for the banking industry of 15% during the 15 years preceding the crisis (1992-2006) and 11% during the 70 years preceding the crisis (1937-2006). While our implied ROE is higher than the average of the past 70 years it is lower than the past 15 years which we think is attainable. We believe that the benefits of increased scale and efficiency stemming from industry consolidation will partly offset the costs of added regulation, implying that the industry can generate a return higher than the average of the past 70 years but not as high as the past 15 years.

READ the report:

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