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Suddenly, Things Are Going “Terribly Wrong” for the Big Banks

·Editor in Chief

Monday’s stock selloff is largely being attributed to the drama in Cyprus, which is potentially a big deal and certainly weighed on global markets overnight. But U.S. proxies weren’t down nearly as much as international bourses – or as initially indicated.

Related: Why Cyprus Is a Bigger Deal Than You Think

In fact, U.S. stocks might be solidly in the green now if it weren’t for another development that bears watching: Weakness in financials.

Monday's slide is also being attributed to Cyprus, which has revived fears of "contagion" emanating from Europe and the related counterparty risk faced by banks. But bank stocks were under pressure before the Cyprus "bail in" hit the headlines.

Starting late Thursday, the financials had a really bad weekend when a Senate report found JPMorgan had misled regulators (and investors) in its disclosures surrounding the now infamous London Whale trade.

Related: 'London Whale' Isn't Dead Yet: JPMorgan Is Out of Control, Rosner Says

The bank’s disclosures “were incomplete, contained numerous inaccuracies, and misinformed investors, regulators and the public” said Senator Carl Levin (D-MI), chairman of the Senate’s Permanent Subcommittee on Investigations.

The 300-page report was just an appetizer for Friday’s hearing, when JPMorgan executives were grilled under oath and former CFO Douglas Braunstein essentially admitted the bank kept regulators in the dark about its mounting losses.

“Things went terribly wrong,” testified Ina Drew, who ran the firm’s Chief Investment Office before stepping down under pressure after the London Whale losses first surfaced last spring. The Senate report and subsequent testimony could expose JPMorgan to additional litigation risk, which is a problem for a number of big banks these days.

Related: Size Counts: Small Banks Are King, The Big Guys Still Have Lots of Problems, Says Whalen

Indeed, things kept going terribly wrong for JPMorgan on Friday when the Federal Reserve gave only conditional approval to its capital plans. But that wasn’t just a JPMorgan story as the Fed said the same of Goldman Sachs.

Both firms had "weaknesses in its capital plan or capital planning process that were significant enough to require immediate attention, even though those weaknesses do not undermine the quantitative results of the stress tests," the Fed declared.

In addition, all the big banks were in the crosshairs Saturday when Dallas Fed President Richard Fisher laid out his plans to break up the “too big to fail” banks at the annual Conservative Political Action Committee (CPAC) conference.

As discussed here last week with Josh Rosner of Graham Fisher (no relation) and co-author of Reckless Endangerment, the fact a speech about breaking up the big banks was delivered at CPAC is an eye-opening development.

Growing conservative support to get tough on big banks “is a sea change and under-appreciated,” Rosner says.

Related: ‘Too Big to Fail’: Conservatives and Liberals See Eye to Eye

Anti-bank sentiment represents an opportunity for rare bipartisan agreement in Washington. Think about it, there probably aren’t that many things that Rand Paul (R-KY) and Bernie Sanders (I-VT) agree on but they do find common ground here.

Sen. Paul doesn’t support breaking up or heavily taxing the big banks, as Sen. Sanders has advocated. But the rising star of conservative politics has expressed support for “something like Glass-Steagall” as well as a limit to FDIC insurance on individual accounts which Rand believes “helps limits the size of banks.”

So while breaking up the ‘too big to fail’ banks is highly unlikely anytime soon, it’s now plausible we could see more serious consideration to a combination of the following:

  • Reinstatement of Glass-Steagall, which separated commercial and investment banking and/or full adaptation of the so-called Volcker Rule, which bans banks from trading their own accounts, i.e. “prop trading.”

  • Requirements to list derivative transactions on an exchange, if not actually regulate the trading thereof.

  • Higher reserve requirements and/or lower maximum leverage ratios.

Many, including my colleague Henry Blodget, remain skeptical that politicians will ever approve regulations with any teeth and bank stocks had been on a tear prior to this recent selling squall. But the reality is the recommendations above make both good policy and good politics. You don't have to be a political genius to see there’s no love lost on Main Street for the “fat cats” on Wall Street. Indeed, some Republicans might now see that running a former private equity executive as their standard-bearer didn't help their cause in November. (To be fair, Republicans may have the reputation as the "party of big business" but going back at least to the Clinton years, Democrats have spent as much time in bed with Wall Street as the GOP.)

More than five years after the financial crisis began in earnest, we may finally have arrived at a moment where there’s bipartisan support to “get tough” on the big banks.

Better late than never.

Aaron Task is the host of The Daily Ticker and Editor-in-Chief of Yahoo! Finance. You can follow him on Twitter at @aarontask or email him at altask@yahoo.com