The US banking and financial system is in need of updating and improving. Ever since our banking system almost brought Armageddon in 2007-2009, we’ve known the system needs a serious overhaul. Reforming the banking system is always a slow and uphill effort because banks are skilled (OK, their army of lobbyists are skilled) at convincing our perpetually myopically-inclined legislative branch to see things their way. 
 
The environment where the latest batch of bank regulations will be developed is not attractive:
  • record numbers of small and medium sized banks are failing.
  • record numbers of small businesses are failing
  • record numbers of consumers are filling for bankruptcy, losing their homes, and losing their jobs.
  • the FDIC is out of money.
 
It is worth noting that in one respect, the US banking system has more risk than it did back in 2007: there are now even fewer large banks than there were prior to the crisis, so the remaining banks hold an even larger portion of the countries assets.
 
We will likely see a focus on delivering new legislation that serves to:
  • reduce the risk of single bank failure initiating a contagion.
  • improve protection of small investors and consumers
  • rebuild the finances of the FDIC
  • reduce leverage taken by banks
  • improve transparency in bank accounting
 
At the peak of the market (2007), the financial component of the S&P500 index had nearly doubled its long term average component. The financials sector of the economy actually adds very little to an economy. It does not produce a good or service that improves society. Rather it is merely focussed on assigning capital efficiently and dispersing risk.  It failed at both of those spectacularly over the past 10 years. For this, it was handsomely rewarded with average paychecks higher than any other sector of the economy.
 
Roughly twelve months ago the accounting rules for banks were changed to permit banks to value their assets -specifically those assets that no one wanted – at the price paid versus the current market price. That’s ridiculous. The organization responsible for developing accounting standards in the US (called the Financial Accounting Standards Board) was brow-beaten into submission by Congress until they watered-down the accounting standard. For those that are scratching their head trying to understand why we care about this, we care because if banks are forced to account for their balance sheet assets like the rest of the world, they’ll likely have to write-down the value of a lot of assets related to US mortgages (still). That in turn means some may either become insolvent or otherwise be forced to raise more capital. Either way, not good for bank stock prices.
 
Well, the FASB rides again. In the coming weeks, the FASB will try to change accounting standards back to mark-to-market for banks. I have every confidence that the same congressmen will make pariahs out of the FASB, and the the FASB will back down again. But this will make for a more difficult climate for bank stocks to make gains.  
 
The Federal Reserve, the US Treasury, and the SEC need to resolve their different views even before we get into the horse trading and pork-barreling that the congress will do. Look for this grand sausage making process to remain on the front burner and for it cause jitters among the banking system and stock markets.