U.S. Banking Regulations and Market Control: Foreign Investors and Nonbanking Industries Interest in Status Quo

David Wyss, chief economist at Standard & Poor’s, recently reported to The Washington Times that the S&P is concerned that the financial reform legislation, now pending as a Senate bill, would have adverse effects on foreign investors. Wyss states that “nearly half of the government’s publicly held debt” is held by foreign investors and the pending reform would be seen as the U.S. government’s “attempts to intimidate the Fed” and an attack on the Federal Reserve System’s independence.

Foreign investors are also looking at the U.S. Congress’s delay in reappointing Federal Reserve Chairman Benjamin Bernanke. On December 17, 2009, the Senate Banking, Housing and Urban Affairs Committee sent Bernanke’s nomination to the floor. A populist grassrote movement is developing in the U.S. against Bernanke’s reappointment. Sen. Bernie Sanders (I-Vt) managed to gain tripartisan support to place a hold on the senate vote until January 2010.

U.S. Government Concern with Fed Supervision and Transparency

Within the financial market reformation debate, U.S. lawmakers have constantly raised the issue of Fed transparency. Sen. Richard Shelby (R-Ala.) expressed the concerns of the major political parites in his questions to Bernanke at the December 3, 2009 reconfirmation hearing:

“If we were to go back, Mr. Chairman, and review the minutes and transcripts of all the Federal Open Markets Committee (FOMC) meetings between 2003 and 2008, I wonder what fraction of the time would have been devoted to issues involving supervision and regulation of … holding companies. Was it half the time? Was it a fourth of the time?”

Bernanke initially responded that in a typical meeting “there would be very little discussion of supervision.” He qualified, however, that “[r]ecently we’ve talked about it quite a bit because of the financial crisis,” he said. “But it depends on the situation.”

“‘Congress has a seat’ on the Fed’s rate setting committee,” said Bernard Baumoh, chief global economist at the Economic Outlook Group in a 12/30/09 The Washington Times article. “[A]s long as the Senate strings out a vote on Mr. Bernanke’s nomination and [on the] legislat[ive] debate” the U.S. government could maintain its seat on the FOMC.

The Elephant in the Room: Non-regulation of the Nonbank Financial Sector

Another question regarding direct government control over regulation of the U.S. banking industry is whether the nonbank financial sector will continue to go unregulated? There has been a huge development within the financial industry of financial entities, products, and transactions that make no reference to the word “bank” in their names.

The biggest of these financial growth markets include hedge funds, holding companies, and derivative trading. The growth of pay day lending within the U.S. domestic market also raises the issue whether there needs to be greater consumer protection against usurious payday lending financing. Charles S. Gardner, former senior official at the International Monetary Fund, notes that the nonbanking sector even operated outside of the reach of the Fed and expresses great concern regarding unregulated derivative trading.

“Requiring open trading of derivatives will help regulators identify potentially risky credit creation outside the regulated banking industry,” writes Gardner in his recent article “What the Senate Must Do Now.” Gardner proposes that the U.S. government needs to take a leading role in fostering global financial regulations.

A Senate floor vote is expected on Bernanke’s reappointment, but has been held over to January 2010. According to a joint statement released by lead negotiators, a “deal could be struck before the Senate reconvenes in January” on the pending financial reforms regulations.

Mergers and Acquisitions: Basic Terminology

In order to grow and/or achieve adequate diversifications, companies often take the route of mergers and acquisitions. An acquisition is when a portion of a company, or the company in its entirety, is purchased by another company.

If the latter is the case, the acquisition of the entire company is also referred to as a merger or the complete amalgamation of one company by another. In most cases, mergers occur when two smaller companies combine their assets and liabilities to form a bigger company.

Mergers can also be defined as takeovers, although a takeover usually implies a hostile transaction. In contrast, in a friendly transaction (takeover), management of both companies usually agrees on the merger and encourages its approval with their respective stakeholders.

Statutory Mergers

When one company ceases to exist as a legal entity and merges all of its assets and liabilities into the purchasing company, this type of a merger is called a statutory merger. There are two types of statutory mergers:

  • a subsidiary merger; and,
  • a consolidation.

In a subsidiary merger, the purchased company (target company or simply target), becomes a subsidiary of the acquiring company (or acquirer). The reason why is often that the target company owns a popular brand and renaming it could potentially cause customer alienation.

In a consolidation, both merging entities cease to exist as former legal entities and agree to form a completely new legal entity. This type of statutory merger occurs when two companies are approximately similar in size and operations.

Horizontal Mergers

In a horizontal merger, the two merging entities operate in the same kind of market, typically as competitors. One of the main reasons why companies pursue horizontal mergers is to achieve economies of scale, which is achieving larger combined operations through consolidation of operations, resources, and trimming of the excess “fat.” As a by-product, with two former competitors now operating as one, higher market presence is also achieved by having one less competitor to worry about and by becoming a larger entity that cannot be easily “pushed around” by other players.

Vertical Mergers

In a vertical merger, the two companies merge along the production process. For example, the acquirer could be a supplier targeting a distributor. Through this type of merger, aside from cost savings, a newly formed entity achieves greater control of the production and distribution.

If an acquirer buys a target company ahead of it in the production chain (e.g. a jewelry manufacturer buying a precious metals mining company), this type of vertical merger is called backward integration. Alternatively, when the acquirer buys a company that is down from it on the production chain (e.g. an iron ore mining company buying a steel manufacturer), this is called a forward integration.

Conglomerate Mergers

Conglomerate mergers occur when the two merging entities’ core businesses are unrelated to each other. For example, General Electric transformed itself into a conglomerate after purchasing numerous companies operating in a wide spectrum of industries, from home appliances, finance, aircraft parts, media, and medical equipment.

Conglomerate corporate structure was very popular during the 1960s to 1980s. The rationale was diversification across both cyclical and non-cyclical industries in an effort to offset potential cash flow volatilities.

At this point, it would be useful to review a short history of mergers in the U.S., which can be read about in the next article in the series.