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Obama treads lightly on Wall Street

June 18, 2009

President Obama, in a speech on the financial crisis at Georgetown University in April, spoke eloquently about the need to move away from a Wall Street-fueled “bubble and bust economy.” But Obama’s proposal for overhauling the financial regulatory system falls well short of his stated goal of making “sure such a crisis never happens again.”

In fact, another major crisis is all but certain if the administration’s plan is enacted as is. I can’t tell you when. Nor can I tell you which financial institutions will be hardest hit. But it will happen because Obama took the path of least resistance when it came to the thorny issue of handling financial institutions that are deemed too big to fail.

Now the simplest solution for reducing the systemic threat posed by the giant financial institutions is to make them get smaller. That way the institutions can either be allowed to fail on their own, or regulators can step in and restructure them in a way that doesn’t threaten the world economy.

But ordering the breakup of a globally interconnected bank like JPMorgan Chase or Goldman Sachs is a tough political sell — especially if the bank doesn’t pose an immediate danger to the financial system. And it’s a position that’s sure to anger many on Wall Street, where some were big supporters of Obama in the election. Realistically, it was never going to happen.

Still, Obama could have chosen a somewhat less confrontational position that would have imposed some hard-and-fast caps on financial institutions that would limit their growth. U.S. banks currently cannot control more than 10 percent of the nation’s total customer deposits. So why not impose a similar kind of cap on the overall derivative exposure a bank can take on, or the percentage of assets a bank can keep in off-balance-sheet structures?

These “growth caps” wouldn’t be popular with Wall Street either. But it would put an outer limit on how big anyone bank could get in a particular market — reining in the potential systemic risk. Moreover, the banks, after bringing the world economy to the brink, have earned the right to be kept on a short leash.

Instead, Obama opted for a far mushier strategy that leaves too much to the discretion of regulators — mainly the Federal Reserve and Treasury — to come up with new capital and leverage requirements.

“You have 88 pages of big picture stuff but few details,” says Barbara Lucas, a long-time banking lawyer and principal with Capital Market Risk Advisors. “The thing that troubles me is the vast grant of undefined power to the Fed and Treasury.”

The Fed also showed little acumen in spotting signs of trouble at the banks it regulated before the crisis burst onto the scene. Treasury was even blinder. Both the Fed and Treasury have a history of being too cozy with Wall Street. And a tough regulatory standard imposed by one set of regulators can be whittled away by subsequent overseers.

Sure, the Fed is supposed to be immune to political swings. But deep down every Fed chairman is a political animal with a distinct political philosophy. Just ask Alan Greenspan.

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