Financial Regulatory Forum

Volcker urges U.S. curbs on big banks’ risky trades

By Reuters Staff
February 2, 2010

By Kevin Drawbaugh and Rachelle Younglai

WASHINGTON, Feb 2 (Reuters) – White House economic adviser Paul Volcker urged Congress on Tuesday to rein in risky investing by big banks to prevent them from becoming “too big to fail.”

The former Federal Reserve chairman — a sage of monetary policy and crusader for tighter regulation whose star is rising in the Obama administration,– faced questions from lawmakers about President Barack Obama’s latest proposals affecting big banks.

Obama stunned financial markets in late January by calling for new limits on banks’ ability to do proprietary trading, or buying and selling of investments for their own accounts unrelated to customers.

Since then analysts have speculated widely about exactly what sort of activities would be off-limits if Congress adds the proposal, formulated by Volcker, to a sweeping package of financial regulatory changes still being debated.

Some see the boundary between proprietary trading and market-making that helps customers as blurred, but Volcker said there was little reason for uncertainty.

“Every banker I speak with knows very well what ‘proprietary trading’ means and implies,” Volcker told the Senate Banking Committee.

“Only a handful of large commercial banks — maybe four or five in the United States and perhaps a couple of dozen worldwide — are now engaged in this activity in volume.”

Under the Obama proposals, banks would not be allowed to establish or maintain a separate trading desk, capitalized with their own resources and unrelated to customer business, said U.S. Treasury Deputy Secretary Neal Wolin, who also testified at the hearing.u.

That could mean barring banks from using such trading desks to speculate on the prices of oil, gas or equity securities, said Wolin, adding that the restrictions should apply to all banks, including the U.S. operations of foreign banking firms that have a U.S. branch and fall under U.S. laws.

DODD BACKS OBAMA PROPOSALS

Senator Christopher Dodd, the Democratic chairman of the committee, said he strongly supports Obama’s proposals.

Senator Richard Shelby, the panel’s top Republican, said he was “quite disturbed” by Obama’s proposals being “air dropped” into a more than year-old financial regulation debate.

But Shelby said he was willing to consider them, with an eye to deciding whether they should be woven into the legislative package being debated now or dealt with later.

In a sign of how the so-called “Volcker rule” may already be having an impact, people familiar with the matter said on Monday that JPMorgan Chase may be rethinking its acquisition talks involving RBS Sempra, a joint venture of Sempra Energy and Royal Bank of Scotland.

The rethinking may be motivated by possible limits on proprietary trading, the sources said.

Volcker — whose tight-money regime broke the back of inflation when he was Fed chairman in the early 1980s under Presidents Carter and Reagan — also wants banks to sever ties to hedge funds and private equity ventures.

“Hedge funds, private equity funds, and trading activities unrelated to customer needs … should stand on their own, without the subsidies implied by public support for depository institutions,” he said.

A second hearing is set for Thursday to hear from executives of JPMorgan and Goldman Sachs <GS.N>.

Members of the banking committee are trying to negotiate a bipartisan regulatory reform bill to avoid a repeat of the financial crisis that jolted markets worldwide and caused the worst U.S. recession in decades.

Deep divisions remain among committee members over issues such as managing systemic risk, bank supervision and consumer protection. Obama’s latest proposals complicated the talks.

The House of Representatives approved a bill in December that called for the biggest regulatory changes since the Great Depression, but the “Volcker rule” was not included.

Obama also called for a new cap on market share for banks that takes into account not only deposits but also nondeposit funding.

NO MENTION OF GLASS-STEAGALL

No mention was made in the testimony of an idea associated with Volcker that he has lately been soft-pedaling reimposing the 1930s-era Glass-Steagall laws that required separation of commercial and investment banking.

The laws were largely repealed in 1999, helping to usher in a wave of consolidation in financial services that some critics blame for the 2008 financial meltdown. Some lawmakers have called for reimposing Glass-Steagall.

“We expect Volcker and others at the hearing to concede that bringing back Glass-Steagall is not viable,” said Jaret Seiberg, financial services policy analyst at investment advisory firm Concept Capital.

Volcker did say that international consensus on appropriate actions to restrict banks’ activities is an attainable goal.

Taken on as an early adviser to Obama, Volcker initially seemed to be having limited impact within the administration. But that changed after Democrats lost a Senate seat in an election in Massachusetts and Obama adopted to a more populist stance.

For the text of Volcker’s remarks, click here.

For the text of Wolin’s remarks, click here. (Additional reporting by Luke Pachymuthu in Dubai and Steve Slater in London; Editing by Kenneth Barry) ((kevin.drawbaugh@thomsonreuters.com, +1 202 898 8390, +1 202 488 3459 (fax)))

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