Obama, On Volcker’s Advice, Proposes Banking Regulations

The proposal, if passed, likely would lead to the breakup of some of the nation’s largest banks.

(January 22, 2010) – President Barack Obama, fresh off a Democratic defeat in the race for the late Edward Kennedy’s Massachusetts Senate seat, has proposed further regulating what the nation’s largest banks can do with depositors’ money.

The “Volcker Rule” regulations – named for the former chairman of the Federal Reserve and current presidential advisor Paul Volcker, who has been touting such changes for some time – would first and foremost prohibit commercial banks from engaging in proprietary trading. Volcker, joining President Obama in Washington for the announcement, had previously stated that he opposes “prop trading” of financial securities (such as the asset-backed securities that are commonly thought to have exacerbated a real estate collapse, leading to the 2008 crisis) by commercial banks. A similar move is being discussed in Europe and the United Kingdom, according to the New York Times.

Also, the proposal would prohibit banks from “owning, investing or sponsoring hedge funds or private equity funds,” according to President Obama. “If financial firms want to trade for profit, that's something they're free to do,” he said in the Thursday press conference. “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.”

This announcement comes on the heels of the President’s proposal to tax America’s largest banks to recover money lost (estimated at $117 billion) under the Troubled Asset Relief Program (TARP). Such a move would likely pit Democrats, now without a filibuster-proof 60 seats in the Senate, against a newly resurgent and enthusiastic Republican party.

While the reason – a quasi-return to the era of Glass-Steagall, where investment and commercial banking activities were separated – and target – large banks such as Citigroup, Bank of America, and JPMorgan Chase – of such regulation is clear, what the move means for the nation’s asset owners is not. The restrictions on proprietary trading would seem to inhibit some banks from the practice of selling financial securities to institutional investors while at the same time engaging in the short-selling of these same securities; however, banks that didn’t take commercial deposits seemingly would still be able to engage in such practices via their proprietary desks.

To contact the <em>aiCIO</em> editor of this story: Kristopher McDaniel at <a href='mailto:kmcdaniel@assetinternational.com'>kmcdaniel@assetinternational.com</a>