Rafferty Capital Markets analyst Richard X. Bove takes a break from Fannie Mae / Freddie Mac commentary to weigh in on Michael Cavanaugh’s recent exit from JPMorgan Chase & Co. (NYSE:JPM), noting that his departure follows the trend of a recent brain drain in the banking industry.

Michael Cavanaugh

Michael Cavanaugh’s departure from JPMorgan

I cannot stop thinking about Michael Cavanaugh’s departure from JPMorgan Chase & Co. (NYSE:JPM) (JPM/$60.93/Hold) and what it means for the financial industry. Mr. Cavanaugh was in strong position at the bank. If a poll of institutional investors were to be taken it is my belief that he was the most preferred candidate to replace/follow Jamie Dimon. His background and training in both the financial and operating areas of the company made him a natural to take the top spot. Moreover, he would make a personal fortune at the bank where he was wanted and respected.

But, he quit. So have 9 other top executives. The brain drain in banking has actually been going on for years. I cover Lazard (LAZ/$46.13/Buy); Evercore (EVR/$57.40/Hold) and Greenhill (GHL/$53.99/Hold). They continually obtain their top talent from top executives leaving the banks. Vikram Pandit may not have decided to leave Citigroup Inc (NYSE:C) (C/$50.30/Sell) but once he was gone, he went in the same direction as Cavanaugh, and the recruits to the advisory companies. He went to the private equity/business development/advisory sector.

U.S. Government Misfires Once Again

The reason that so many people are leaving is because they have had enough. They are not thieves or crooks. They are intelligent, creative, effective people. Yet the government is unable to stop attacking them; scrutinizing everything that they do; and trying to curtail their business activities. The government wants to break-up the big banks; change the functioning of the capital markets; and return the United States to financial isolationism.

No one understands this better than Mr. Cavanaugh. He was called in to clean up JPMorgan Chase & Co. (NYSE:JPM) Morgan’s “London Whale” mess. Mr. Cavanaugh has dealt with the government’s unbending desire to cripple his company. He clearly wants out.

The theory that the regulators is pursuing is that if the big banks can be throttled then the smaller banks will rise to take their place in the U.S. financial system. This concept never had a chance to succeed. The reasons were twofold:

• The smaller banks lacked the product array that the big banks offered; and
• The smaller banks were being harmed, in some cases like debit card and overdraft rules, worse than the big banks by the new rules.

The New Competitors

By over-regulating banking, the regulators did not help the smaller banks. The regulators re-opened the shadow banking market. They created opportunities for entrepreneurs with the skills and freedom from regulation to treat the banking system like a beached whale. Banks have now become the source of business for many companies many of whom can almost take transactions at will.

The regulators have succeeded in deregulating the financial markets in a fashion never envisioned by the advocates of this policy in the past. They have heightened the risk in the system and they have lost control of the most vibrant parts of the financial industry.

This creates opportunity for Mr. Cavanaugh. It also creates opportunity for investors. Business Development Corporations, REITs, Master Limited Partnerships, Private Equity funds, payday loan companies, and pawn companies will all benefit. There will be numerous offerings of new financial companies in the public markets. Money can be made here not just by Mr. Cavanaugh but by everyone else, also.