If the stock market keeps taking even the half the kind of hits it took Thursday over the next few days, you can expect an outpouring of complaints from the laissez faire crowd about how the White House’s proposal to restrict banks from engaging in another "binge of irresponsibility" is going to curtail economic expansion. In fact, the proposal may provide an excuse for a long-expected correction in the credit-driven rise in stocks since March. The Wall Street Journal, Financial Times and other critics have labeled the announcement "bank bashing."
They would have said the same thing last March, too, if the President had made his announcement then – which he should have. Those financial institutions were treading water back then, weak financially and politically. Now, thanks to taxpayer-funded props and an improved economy, they’re all stronger. But they also have to justify their gripes against the populist anger generated by the fact that they have continued to behave just as they did when they boosted us into the economic mess that has put millions out of work and out of their homes.
Whatever their complaints, however, one thing is clear, former Fed Chief Paul Volcker, who was seen as pretty much out of the loop even as an outside-the-inner-circle adviser of the Obama administration over much of the past year is suddenly front and center with his name attached to the new policy of tighter banking controls the President announced today.
The "Volcker Rule" is about the best branding imaginable, given the former Fed chairman’s statements in England a month ago challenging executive pay at banks and saying that the industry’s biggest innovation in the past few decades was not credit default swaps but the ATM. Certainly, Volcker’s mark was not so prominent in last June’s White House white paper [pdf] on financial reform. Today, however, the President said:
The fact is, these kinds of trading operations can create enormous and costly risks, endangering the entire bank if things go wrong. We simply cannot accept a system in which hedge funds or private equity firms inside banks can place huge, risky bets that are subsidized by taxpayers and that could pose a conflict of interest. And we cannot accept a system in which shareholders make money on these operations if the bank wins but taxpayers foot the bill if the bank loses.
I am 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.
There are good reasons the proposal was not named the Geithner Rule or the Summers Rule or, most especially, not the Rubin Rule, since those worthies were co-conspirators in efforts to deregulate the financial system in the ‘90s and to put up obstacles to re-regulation now.
As always, of course, the devil of the proposal will be in its details and what those details look like when it emerges from the Senate Banking Committee. The White House has made clear that it is not proposing a return to Depression-era laws, which is code for, among others, the 1933 Glass-Steagall banking reform act that was repealed in 1999 thanks in part to two high-level members of the Obama administration. Interestingly, Volcker is said to have advised Senator Maria Cantwell when she was drafting, together with Senator John McCain, a bill to restore Glass Steagall.
Not all problematic institutions were mixing consumer deposits with risky trading in complex financial instruments, however. And controlling them will need doing, too. One Senator who has more in mind than the White House in this regard is Bernie Sanders, who had this to say:
"President Obama’s proposal is a major step forward to limit the greed and reckless behavior of Wall Street that has caused so much damage to the economy. We need to do everything we can to limit the size of too-big-to-fail financial institutions and end the gambling addiction on Wall Street.
"One of the reasons I am strongly opposed to the re-nomination of Ben Bernanke is that, in truth, he has had the power to do this from day one. Our goal must be to create a new Wall Street that invests in the productive economy creating decent paying jobs for all Americans."
Sanders has authored S. 2746, The Too Big to Fail, Too Big to Exist Act, which would require the Treasury Department to break up overly large institutions. So far, no co-sponsors.
But, while today's proposals do not go far enough, they are two overdue steps in the right direction.