Obama Proposal on Banks = Less Loans and Less Liquidity

Last week President Barack Obama launched a direct attack on Wall Street with a proposal to limit the size and scope of the nation's largest banks. While details were limited, Obama's plan will seek to ensure that no bank will own, invest in or sponsor a hedge fund or a private equity fund, or proprietary trading operations unrelated to serving customers for its own profit. In addition, the proposal will place broader limits on the excessive growth of the market share of liabilities at the largest financial firms.

Obama's proposals appear very politically motivated and will likely see changes along the legislative processes. That said, it is clear that Obama is placing the blame of the financial crisis squarely on the back of the big banks.

Today analysts at Goldman Sachs (NYSE: GS), which themselves will likely be impacted by the proposal, commented on what it would mean for the banks and implications for the general economy.

The firm said restrictions on total liabilities could force large banks to reduce the size of their loan portfolios and restrictions on proprietary trading could make large banks less able to provide liquidity.

On reducing loan portfolios, the firm said "forced reductions in big banks' balance sheets could lead to further deleveraging." They said this would force big banks to reduce their loan portfolios at a time when loans are already down 8%.

On limiting proprietary trading, the firm said, "for large banks, over 90% of "proprietary" trading revenues come from executing client transactions. Broad or ill-defined restrictions on proprietary trading could therefore reduce the ability of large banks to provide liquidity." As learned during the crisis, lower liquidity, "raises, not reduces, risk premia," according to the firm.

Despite the heightened regulatory risk, the firm sees compelling values in large cap banks. Their top picks in the sector remain JP Morgan (NYSE: JPM), Bank of America (NYSE: BAC) and Wells Fargo (NYSE: WFC).

So all in all, Obama's proposal which he claims will help Main Street will actually hurt it further.