Three cheers for Obama’s banking reforms

By Felix Salmon
January 21, 2010
press release line by line:

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Barack Obama is coming out swinging today, and good for him for doing so. Let’s go through the press release line by line:

WASHINGTON, DC- President Obama joined Paul Volcker, former chairman of the Federal Reserve; Bill Donaldson, former chairman of the Securities and Exchange Commission; Congressman Barney Frank, House Financial Services Chairman; Senator Chris Dodd, Chairman of the Banking Committee and the President’s economic team to call for new restrictions on the size and scope of banks and other financial institutions to rein in excessive risk taking and to protect taxpayers.

Note here how Geithner and Summers just become part of “the President’s economic team”, while Volcker gets top billing. This is, as Simon Johnson says, an important change of course — and it’s one which is being supported by both Dodd and Frank, so there’s a good chance it can pass. After all, the Republicans tend to hate Wall Street even more than the Democrats.

The President’s proposal would strengthen the comprehensive financial reform package that is already moving through Congress.

This is also a good sign: in the wake of Dodd making noises about softening existing legislative proposals, Obama has come out and said, quite rightly, that we should push hard in the opposite direction, and tighten them up.

“While the financial system is far stronger today than it was a year one year ago, it is still operating under the exact same rules that led to its near collapse,” said President Barack Obama. “My resolve to reform the system is only strengthened when I see a return to old practices at some of the very firms fighting reform; and when I see record profits at some of the very firms claiming that they cannot lend more to small business, cannot keep credit card rates low, and cannot refund taxpayers for the bailout. It is exactly this kind of irresponsibility that makes clear reform is necessary.”

OK, so this is populism. But populism in the service of a good cause is no great sin.

The proposal would:

1. Limit the Scope-The President and his economic team will work with Congress to ensure that no bank or financial institution that contains a bank will own, invest in or sponsor a hedge fund or a private equity fund, or proprietary trading operations unrelated to serving customers for its own profit.

This is a good idea, but cutting back on prop trading, in particular, is going to be hard. Goldman Sachs has told me repeatedly that they don’t have prop trading: everything they do is ultimately for the benefit of their clients. Absent a corner of the trading floor with a big flashing “prop desk” sign above it, in practice it’s very hard to draw the line between the kind of daily trading that any broker dealer has to do, on the one hand, and proprietary trading for a bank’s own account, on the other. Both of them involve the bank taking risk and making money, after all.

The restriction on sponsoring hedge funds and private-equity shops makes sense: after all, the in-house hedge funds at Bear Stearns played a large role in its demise. The banks will just spin off those holdings to shareholders, I don’t think this is a big deal for them.

2. Limit the Size- The President also announced a new proposal to limit the consolidation of our financial sector. The President’s proposal will place broader limits on the excessive growth of the market share of liabilities at the largest financial firms, to supplement existing caps on the market share of deposits.

I love this. It’s bank liabilities which cause systemic risk: that’s why it’s bank liabilities which are subject to the bank tax. And as too-big-to-fail banks increasingly rely on wholesale liabilities rather than a more stable deposit base, it’s important to place some kind of restrictions on the degree to which they can do so. In his press conference, Obama said that banks should not be allowed to stray too far from their mission of serving depositors: he’s moving, here, towards a vision of narrow (or at least narrower) banking. Good for him.

Banks stocks are down in the wake of the speech, but not dramatically: it’s easy to get overexcited about a 6% fall in JP Morgan’s share price while forgetting that it’s still over $40 a share, compared to less than $15 in March. Indeed, its all-time high, back in 2007, was barely over $50. Let’s get the Republicans on board with this, and push it through. It’s probably our last chance to enact meaningful financial reform this generation.

20 comments

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I applaud President Obama’s indications. If he acts accordingly and accomplishes some of what he has outlined I applaud it even more.

The mess that the world financial system is in today can only be laid at the feet of financial institutions, which used the public trust and money to gamble on excessive returns.

Glass-Steagal protected this country for decades. Bank-deregulation threw our financial system to the dogs.

The reasons that bankers are balking at President Obama’s proposals is that they want:

a) to continue being overly compensated for doing nothing (not lending)
b) for losing the ABILITY not to mention the obligation, to do risk analysis and form relationships which are the foundation of the financial services industry
c) they see the end of the government free boon which they’ve just translated into personal gain (bonuses for officers and managers far exceeding their productive ability)
d) for losing the chance at making money the new-fashioned way (risking a lot of someone else’s money without doing any homework) and having to return to . . .

MAKING MONEY THE OLD FASHIONED WAY . . .LONG HOURS, LOWER PAY, HARD WORK. . . STUDY, . . RELATIONSHIP FORMING. . . .ETC.

Congratulations President Obama . . to the bankers out there get used to a 38% retracement in your EARNINGS !!!!!!!

Posted by firstbridge | Report as abusive

Yay for good intentions. But it just flat does not matter. What makes anyone think this would not be filibustered?

Posted by scott1959 | Report as abusive

Sounds so simple but well thought-out reforms. I love it.

Posted by hexazebra | Report as abusive

Please God, all I ask for is a Republican filibuster on banking regulation. Let’s schedule it for September – and make sure it dominates every day on cable news for at least two weeks. Let’s have cloture motions every 48 hours for two weeks – that would be fabulous.

We’ll see if Barack the Timid has learned his lesson.

Posted by Dollared | Report as abusive

“the Republicans tend to hate Wall Street even more than the Democrats.”

Are you serious?

Posted by NoDiv4 | Report as abusive

Hallelujah. What took so long? Now remember: K.I.S.S. (keep it simple, stupid) and get those senators, congressmen and women and pundits off their keisters and promote the hell out of this…then DARE the GOP not to vote for it. For heaven’s sake OWN IT!

Posted by zippity | Report as abusive

The rules need to be simple and straight forward. No “if” interpretations allowed. The banks and brokers are just like wild kids. They only want daddy’s help when they get into trouble. The responsible parties of the 2008 fiasco need to be brought to justice also.

Posted by fred5407 | Report as abusive

Sure thing Felix, another poorly-written article that barely disguises your contempt for the financial markets. What is it with you know-it-all journalists and your hero Obama?
And what is this about Republicans hating Wall Street more than Democrats? HUH?
I suppose that some Washington bureaucrats, ever-wise and all-seeing, will now figure out just how big a bank can get. These are the same guys who lost count of the budget deficit and the liabilities of Fannie and Freddie and are STILL sinking money into Chrysler and GM so Obama’s union buddies won’t vote against him in November – a very real possibility. So now Obama comes up with this banking reform bill – more like populist vengeance, in my view – seeking to deflect attention from his own achievement-less presidency. And Felix, you go right along with it, applauding even. Get out in the real world and see how things really work. Being a pundit means you should have some experience of what you’re talking about.

Posted by Gotthardbahn | Report as abusive

Paul Volker was Reagan’s Fed Chief. I believe in him and his “good ole time religion”. We desperately need another Ronald Reagan, and while I see none out there in either party, I’m at least comforted there are some remains of the old regime, at least when it comes to fiscal matters. I’m also more hopeful now that Obama has tapped his advice and experience.

It’s time for some real reform. Not a complete return to Glass-Steagal, but more than what exists today.

Posted by Surveymarc | Report as abusive

I work at a bank and agree in part with what Barack is trying to do here. Before the government deregulation back in the 1990′s, where banks and investment companies had to maintain separate books, the environment and culture on Wall Street was slightly better. I don’t necessarily like him once again stepping in to the private sector and imposing his will but he is correct in that our current environment has to change. If one really studies the history and basics of banking, it’s pretty simple. Pay depositers a rate of interest, charge borrowers a slightly higher rate of interest, service your customers and earn a honest profit. Derivatives, credit default swaps, hedge funds, options and futures trading, trading on margin, I could go on – these are the most dangerous and hardest concepts for the average investor to understand. The harder something is to understand for the majority, the easier it is for those in power to exploit it. Banks and broker/dealers alike need to get back to basics, or at least compartmentalize the aforementioned strategies and products away from normal banking.

Posted by jrichards8821 | Report as abusive

Away from normal banking, and away from GOVERNMENT BAILOUTS!

Posted by bboaze | Report as abusive

Yes, the government has proven their ability to manage and regulate. Wait, what does the goverment manage well again? Oh right, nothing! So let’s support these self-seeking, incompetent bureaucrats in their quest to regulate banking some more. What an insane country this has become.

Posted by ccttl | Report as abusive

1. It is time for us to heal. After the largest bailout in history, we must now let the Central Banks of the Federal Reserve hold onto the small capital that they have so the Obama Administration’s economic recovery can take form. The capital is needed to finance job creationism. President Obama’s 2.2 trillion dollar recovery plan paid bills, now, the next phase is for locally formulated projects to hire people in their given areas. The money will back these projects.
2. As a commonwealth, we must protect our banks. Having cash on hand assist banks who can now invest in their local communities to prevent urban blight and business flight. Let keep capital and money in our local communities. It is time to leave the Old World economics behind. Stock values of our Central Banks will determine the stock value of our Blue Chip corporations this a daisy chain affect of our economy. We must save our banking institutions from self-destruction.

Antonio Ivan Easterling
The Proletarian

Posted by Proletarian | Report as abusive

This proposal by Obama will do nothing.

Although I applaud Obama’s attempt to actually start addressing the financial sector’s trouble, this is a poor attempt. It almost seems like it is something they came up with in a day without thinking much about it to get the media talking about something besides Scott Brown and Healthcare.

Prop trading, hedge funds, and private equity divisions at the banks had very little to do with their problems. Larry Summers was just interviewed on CNBC and said that this is aimed at addressing potential future problems… But shouldn’t we focus on the current issues that catalyzed the crisis we just had before we go on to predicting future problems?

If Obama wants real reform that will be productive, we need to have higher Tier 1 capital requirements for banks, have lower leverage requirements, and mostly eliminate the too big to fail (TBTF) problem. Obama wants to address this by breaking up investment banks and commercial banks… but this wouldn’t have changed anything with Lehman’s or Bear’s collapses, which tipped the dominoes on this mess, and is simply a dumb idea. By bringing back Glass-Steagall we would just cripple our financial firms to international competition and many of their employees would defect to foreign firms.

I think the solution should be more freedom of choice. This sounds odd at first, but by that I mean that banks should be able to choose whether to have FDIC insurance (aka taxpayer insurance) and access to the Fed’s discount window, in which case they will be highly regulated and not allowed to hold securities with less than a AAA rating. However, if JPMorgan does not want to spin Chase off, they can choose to do that but will be considered more risky by people who want to bank with them. You would therefore have “narrow banks” that would just do more traditional lending, credit cards, etc, and the investment houses that can still be competitive and engage in whatever activity they want, so long as their leverage does not create too much counter-party and systematic risk.

On the investment banking side, the higher capital requirements and lower leverage requirements will help avoid Lehman Part 2. If investment banks make lots of money, they good for them, they earned it and it’s better for our economy, so long as it doesn’t put it at risk like it can now via the credit markets.

Posted by jtknop | Report as abusive

A question for anyone who is for more government regulation and control of the financial system, have you ever watched CSPAN when they bring in hedge fund managers, the investment bank CEOs, Bernanke, Paulson?

Our career politician “representatives” up there look like utter fools when trying to even understand how the financial system operates. Why is the world would you ever want to allow them to have much day-to-day control of there huge and highly sophisticated financial firms? We saw what happened with Fannie and Freddie after they wanted “more equality” with lending and forced them to buy low quality loans, thereby bankrupting them. Now all the rest of the banks still standing get to pay for the loss when they are still on the rocks! How fair is that?!

I can’t stand these politicians. There should be a rule they have to work in the private sector for at least 10 years before holding public office, along with terms limits so they have to go back to it and experience the effects of their decisions.

Posted by jtknop | Report as abusive

The law is already written, it’s in the Library of Congress word for word, Re-instate Glass-Steagal.

Posted by NotPleased | Report as abusive

After an upsetting loss of MA senate race, Obama is scrambling his populist agenda: reflecting the public anger at Wall St. My message too you Mr. President, ‘TOO LATE TO ACT’.

Posted by Hanan | Report as abusive

Why is it hard to distinguish prop trading from trading on behalf of clients? You say, “..in practice it’s very hard to draw the line between the kind of daily trading that any broker dealer has to do, on the one hand, and proprietary trading for a bank’s own account, on the other. Both of them involve the bank taking risk and making money, after all” but isn’t the distinction clear? Either they the trade involves the bank’s own money or it involves the money of their depositors. Why is that so hard to account for?

Also, politically speaking, I love the way this sets the crazy “bureacrats are stifling free trade” pro-business conservatives against the Tea Party Nation.

Posted by mediajunkie | Report as abusive

Obama is featured in a movie exposing greedy hedge funds and market manipulation called “Stock Shock.” Even though the movie mostly focuses on Sirius XM stock being naked short sold to hell, I liked it because it gives the average guy a better understanding of the dark side of Wall Street. DVD is everywhere but cheaper at http://www.stockshockmovie.com

Posted by MTFan | Report as abusive

As an employee of JP Morgan Chase I am concerned about a recent directive from management that they will destroy all e-mails on 5/31/10 that are over 60 days old.

Chase management claims costs of maintaining older e-mails as a contributing factor for this decision. This is an utterly ridiculous reason in light of today’s ultra-cheap storage drives and systems. The cost of maintaining all e-mails on various servers and locations would not amount to more than a few thousand dollars. When compared to the billions and trillions that Chase handles daily this is a minuscule amount.

I believe there is more to this action than Chase management wants us to know about.

Posted by Tsap | Report as abusive