President Obama on Thursday announced plans to restrict the operations of the nation’s largest banks in order to reduce the systemic risks they pose to the entire financial system and economy beyond.
Paul Volcker, the former Federal Reserve chief (1979-1987) and the current chairman of the president’s Economic Recovery Advisory Board, who stood next to Obama at the president’s White House announcement today, has advocated for such limits, thus leading to the President calling the new proposal the “Volcker Rule”.
“For while the financial system is far stronger today than it was one year ago, it’s still operating under the same rules that led to its near collapse.
These are rules that allowed firms to act contrary to the interests of customers, to conceal their exposure to debt through complex financial dealings, to benefit from taxpayer-insured deposits while making speculative investments, and to take on risks so vast that they posed threats to the entire system. That’s why we are seeking reforms to protect consumers.
We intend to close loopholes that allowed big financial firms to trade risky financial products, like credit-default swaps and other derivatives, without oversight; to identify system-wide risks that could cause a meltdown; to strengthen capital and liquidity requirements, to make the system more stable, and to ensure that the failure of any large firm does not take the entire economy down with it.
Never again will the American taxpayer be held hostage by a bank that is too big to fail.
Now, limits on the risks major financial firms can take are central to the reforms that I have proposed. They are central to the legislation that has passed the House, under the leadership of Chairman Barney Frank, and that we’re working to pass in the Senate, under the leadership of Chairman Chris Dodd.
As part of these efforts, today, I’m proposing two additional reforms that I believe will strengthen the financial system while preventing future crises.
First, we should no longer allow banks to stray too far from their central mission of serving their customers. In recent years, too many financial firms have put taxpayer money at risk by operating hedge funds and private equity funds and making riskier investments, to reap a quick reward.
And these firms have taken these risks while benefiting from special financial privileges that are reserved only for banks. Our government provides deposit insurance and other safeguards and guarantees to firms that operate banks.
We do so because a stable and reliable banking system promotes sustained growth and because we learned how dangerous the failure of that system can be during the Great Depression. But these privileges were not created to bestow banks operating hedge funds or private equity funds with an unfair advantage.
When banks benefit from the safety net that taxpayers provide, which includes lower-cost capital, it is not appropriate for them to turn around and use that cheap money to trade for profit. And that is especially true when this kind of trading often puts banks in direct conflict with their customers’ interests.
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 a bank wins, but taxpayers foot the bill if a bank loses.
It’s for these reasons that I’m 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”. [emphasis added]
It’s hard to tell if this is a genuine shake-up. One thing though is for sure, the latest plan to curb bankers’ reckless behavior does not really look like a complete return to the days of Glass-Steagall.