Volcker rules

The remarks:

Click here to read the text.

Obama is making two new proposals in addition to the Too Big to Fail Tax.

First proposal:

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.

As others have observed, this sounds like a modern version of Glass-Steagall. The creators of the FDIC realized that it was a bad idea to let banks gamble in financial markets using taxpayer-insured deposits. (Duh.) This restriction was in place for most of the 20th century, but in response to lobbying by banks and an extreme de-regulatory ideology — I am sorry, my Republican friends, but them’s the facts — Glass-Steagall was weakened through the 80s and 90s and finally repealed altogether in 1999. And boy, how well our financial sector has served us since then, eh?

But deposit insurance is not the only public support banks receive. The Federal Reserve’s liquidity facilities are a critical piece of the puzzle. One reason Goldman Sachs et. al. are reporting blow-out 2009 earnings — like $4.79 billion in Q4 alone — is that they can borrow from the Fed at 0.25% interest and buy anything at all, say U.S. Treasuries, earning a certain profit on the interest rate spread. The Fed’s discount window and related “emergency liquidity facilities” are supposed to exist to avert panics and handle bank runs. The basic principles were laid out well over a century ago — in times of panic, a central bank should “lend freely but at a penalty rate”.

The Bernanke Fed has thrown those principles out the (discount) window, by lending freely at no rate whatsoever, and continuing well past the panic. Instead of merely providing liquidity during a run, these facilities are being abused to generate obscene banking profits in a moribund economy. I suspect our Fed thinks they are “recapitalizing the banking system”. Heck, maybe that is even a worthwhile goal. But bank executives and employees are also walking off with billions of dollars in free money for doing literally nothing.

The reason Goldman Sachs, Morgan Stanley and the rest of the investment banks turned themselves into commercial banks in 2008 was to access these facilities. If they are capable of re-paying TARP and awarding themselves obscene compensation, clearly they no longer need to be recapitalized, and it is past time to cut off their direct line to the Fed’s printing press.

This is what the “Volcker rule” will do. I hope.

Second proposal:

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.

This one is a lot more vague. It sounds like a recognition that size itself is a problem, and I agree with that. But according to Prof. Johnson, “The White House background briefing is that their proposals would freeze biggest bank size ‘as is'”. If true, this is entirely inadequate. The key concept is very simple: Too big to fail is too big to exist.

But on the bright side, the debate is just getting started. Time to pay attention again.

Finally, for the cynical view. Perhaps the Democrats are just doing this in response to the “Boston Massacre”. (Actually, that much is nearly certain.) Perhaps the whole idea is to keep their Wall Street masters happy by failing to pass any meaningful reform, while blaming the Republicans for that failure. Then they can pander to the populace by saying, “Well, we tried!” I actually consider this moderately likely, and it might well be a winning formula for November.

Meanwhile, Chris Dodd still heads the Senate banking committee, and whoever will be signing his paychecks in 2011 probably wants all of these proposals to die well before they reach the floor. Can’t wait to watch him attempt to square that circle.

I also note that whoever controls the Dow does not appear to like these proposals. A warning shot across Obama’s bow, perhaps?

Bottom line: Call your Congressworms. Tell them you support the “Volcker Rule”, you are watching carefully, and you vote.