First, we should no longer allow banks to stray too far from their central mission of serving their customers. In recent years, too many financial firms have put taxpayer money at risk by operating hedge funds and private equity funds and making riskier investments to reap a quick reward. And these firms have taken these risks while benefiting from special financial privileges that are reserved only for banks.
Our government provides deposit insurance and other safeguards and guarantees to firms that operate banks…
But these privileges were not created to bestow banks operating hedge funds or private equity funds with an unfair advantage. When banks benefit from the safety net that taxpayers provide –- which includes lower-cost capital –- it is not appropriate for them to turn around and use that cheap money to trade for profit. And that is especially true when this kind of trading often puts banks in direct conflict with their customers' interests…
It's for these reasons that I'm proposing a simple and common-sense reform, which we're calling the "Volcker Rule"—after this tall guy behind me. Banks will no longer be allowed to own, invest, or sponsor hedge funds, private equity funds, or proprietary trading operations for their own profit, unrelated to serving their customers. If financial firms want to trade for profit, that's something they're free to do. Indeed, doing so –- responsibly –- is a good thing for the markets and the economy. But these firms should not be allowed to run these hedge funds and private equities funds while running a bank backed by the American people.
In addition, as part of our efforts to protect against future crises, I'm also proposing that we prevent the further consolidation of our financial system. There has long been a deposit cap in place to guard against too much risk being concentrated in a single bank. The same principle should apply to wider forms of funding employed by large financial institutions in today's economy. The American people will not be served by a financial system that comprises just a few massive firms. That's not good for consumers; it's not good for the economy. And through this policy, that is an outcome we will avoid.
Despite or because of the combative tone of Obama's remarks (among other things the president declared himself "ready to have…a fight" with congressional and financial leaders), White House economic advisor Austan Goolsbee has been dispatched to deny that the president is seeking to re-impose the Depression-era Glass-Steagall Act. David Corn has a nice roundup of Goolsbeeisms. Corn also notes that the podium positioning and name checking at this morning's event were all about former Fed Chairman Paul Volcker and not at all about Treasury Secretary Tim Geithner, advisor Christina Romer, or any other members of the president's brain trust.
What will the new regs do? Not much. Commercial banks already have capital limits on affiliate investments, and the repeal of some Glass-Steagall provisions under Bill Clinton, after a flurry of interest in 2008, turned out to have had little to do with the long-overdue correction in the still-inflated real estate market. Nor would investment limits have prevented, for example, the failure of a bank like Countrywide, which went down on the basis of bad mortgages. (Even commies agree that mortgage lending is a basic operation of a bank, and there's nothing in the proposal that would do anything to change that—though it might limit a bank's exposure to the mortgage-backed securities market.)
The distance between the president's proposal and the behavior of the financial markets can be seen in this exchange between Sen. Maria Cantwell (D-Washington) and a CNBC panel. Under heavy questioning, Cantwell waxes metaphorical, with flames burning up dark markets and grand implosions:
We have a lot of work to do to get money flowing again to small businesses. We have something like an 83 percent increase in small business bankruptcies, and still the money is going through these large institutions into dark markets.
But Sen. Cantwell, I think that what Sue's getting at: Many people are saying that restoring Glass-Steagall would not have prevented the financial crisis.
Oh I think that you have to be specific about the details, but clearly a line like Glass-Steagall is important and in making sure federal regulators don't write any loopholes into the statute that allow them to get around Glass-Steagall.
Sen. Cantwell, aren't you afraid that if we do this we hobble U.S. banks and we let foreign banks become far larger and beat em to the punch.
No, I'm concerned that the standard of the United States, if it continues to be allowing dark market activity with reserves of U.S. deposits, that that kind of activity around the globe will funnel into an even larger implosion than what we saw in September of 2008.
Do we know for sure, guys, that deposits went into this stuff? I thought the bank's own capital did, but there were rules, even with the elimination of Glass-Steagall, that prevented banks from using deposits for high-risk stuff.
No, it's the capitalization of those deposits, the capitalization of them.
Sen. Cantwell, correct me if I'm wrong here, but an awful lot of companies that seemed to precipitate this crisis, like Bear Stearns, or became victims of it like Lehman, weren't sort of federally regulated banks, and neither was Morgan Stanley nor was Goldman Sachs in a major way at the time the crisis was at its worst. They weren't really banking operations, they were trading houses. So how does this then do away with some of the problems—and AIG as Sue mentioned—how does this do away with the problems that we all think are systemic risk?
It isn't a solution in and off itself to the problem that you have a derivatives market that is a dark market, not on exchanges and without transparency. But when you combine the commercial banking and the investment banking, you add fuel to that fire that is burning in the dark markets, and it implodes to a much grander scale as we saw with credit default swaps. So they are related but separate issues. And I think Mr. Volcker has spoken out saying you have to have the over the counter derivative markets excluded from commercial banking.
I had thought it was illegal even now under the rules, to use depositor money for risky stuff, and you said it's the way they capitalize deposits. I'm not sure I understand that. Could you explain that to me please?
Well, when you take commercial banking and merge it with investment banking, and obviously a lot of money is flowing into over the counter derivatives, and my objection is not enough is flowing into business investment, into manufacturing, into small business activities. People are making a ton of money creating something like a $50 billion derivatives market, much of which is dark.
Update: Jake Tapper reports that Geithner is getting cold feet about the plan too. Thanks to commenter virginia for sending along Mish Shedlock's tentative thumbs up for the proposal. Mish also argues for removing Goldman Sachs' status as a protected bank holding company. Goldman's status as a mom and pop bank is certainly one of the largest and most obvious frauds currently being perpetrated. As far as I can tell, Goldman has not made a single gesture at developing a retail banking arm since issuing a press release to that effect almost two years ago.