S&P heavyweights
At the end of June, financial companies accounted for 20 percent of the S&P and weigh heavily on the index. The next largest sector is information technology, with a 14 percent weight in the index.Bank stocks have always been vulnerable in an economic downturn because they end up holding loans that sour with the economy. That will once again be the case if the economy weakens, in spite of claims of advanced risk management techniques. But their role as potential facilitators of improper activities at companies like Enron or WorldCom or even as intermediaries who helped inflate the bubble is an additional worry for investors.Some of the nation's biggest and most trusted banks are in this fix at least partly because of their increased reach in all areas of financial services in recent years. The Financial Modernization Act in 1999, eliminated most of the barriers to certain business set up for banks under Glass-Steagall, the law that came out of the Great Depression. Undoing Glass-Steagall allowed commercial banks to compete with investment banks for the right to sell securities to investors. And the larger banks approached the business aggressively.
There are considerable risks associated with the growth of financial services conglomerates. One is that top management and the board of directors cannot possibly know what lower and middle-level employees are doing inside the bank. "Senior management and the board of directors must have very comprehensive orientation, knowledge and understanding of what's going on and in many instances that is not the case," said Henry Kaufman, the economist and head of Henry Kaufman & Co in New York.And the nation's financial system, he said, is put at risk when these companies become huge conglomerates.
Monopolistic tendencies
"These conglomerates tend to move toward monopolistic practices," Kaufman said. They are saying: "We want to be your banker, which means we want to make you the loan, syndicate the loan, underwrite your bonds and distribute them, we want to do your stock issues, we want to place your commercial paper and we want to manage some of the assets in your pension funds. This not only diminishes competition, but it creates institutions that are too big to fail, because if they would fail then the response is they pose a systemic risk."
Some analysts suspect that in the interests of grabbing more of the lucrative securities underwriting deals that had been the province of the investment banks, commercial banks may have been eager to advise companies on how to get around tax rules and accounting regulations or leverage their balance sheets excessively. While such strategies may have been acceptable even as recently as last year, they are now drawing the attention of Congress and regulators and the ire of investors.
The work that JP Morgan Chase did for Enron was plain-vanilla stuff, according to its executives. "They are a normal financing arrangement," William Harrison Jr., the bank's CEO said. After Enron's failure, normal financing arrangements like these have become questionable.
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