We have a little more detail on President Obama's new proposal for the financial sector:
1. Limit the Scope -The President and his economic team will work with Congress to ensure that no bank or financial institution that contains a bank will own, invest in or sponsor a hedge fund or a private equity fund, or proprietary trading operations unrelated to serving customers for its own profit. .
2. Limit the Size - The President also announced a new proposal to limit the consolidation of our financial sector. The President’s proposal will place broader limits on the excessive growth of the market share of liabilities at the largest financial firms, to supplement existing caps on the market share of deposits.
Again, without enough detail to see if the execution will match the principles, this is a pretty big deal. Proprietary trading especially is where banks have made huge profits, and they will fight like maddened animals to protect that profit center. Without more detail on how the limits on the market share of liabilities will be measured and enforced, it's hard to say how effective they'll be, but that's probably the best angle to take when thinking about shrinking bank size.
The key dynamic that makes this a real change from previous proposals is the switch from discretionary regulation to set rules about what banks can and cannot do. Nonetheless, Treasury officials point out that these ideas have long been part of the administration's plan; for instance, last June's White Paper [PDF] said that the government "should tighten the supervision and regulation of potential conflicts of interest generated by the affiliation of banks and other financial firms, such as proprietary trading units and hedge funds." In October, Treasury Secretary Tim Geithner told the House Financial Services Committee that regulators should be able to limit bank activities and compel them to shrink and separate, an option that was included in the House bill and the Senate's initial draft. Now, though, the president is apparently set to take away regulatory discretion and mandate that no banks will have these types of business, which is a major step.
See also: Rortybomb, "Towards a 21st Century Glass-Steagall."
More to come...
Update: Hearing back from an independent expert Bard College's Jan Kregel, two things to watch out for: Though getting banks out of the proprietary trading business is key, most are also engaged in "asset management;" running investment funds of customer money that are technically independent but often function as extensions of the prop trading desk. Any attempt to rein in proprietary trading has to include restrictions on asset management. On the size caps, measurement of liablities continues to be difficult (remember the on-going debates over accounting practices like mark-to-market) and elastic (caps on deposits have historically been both elastic and exceeded), so an anti-trust approach may still be the most effective way to limit bank consolidation.
Kregel also adds that without the ability to make easy money trading on money borrowed cheaply from the Fed, bankers will have an added incentive to get back into productive lending.
-- Tim Fernholz
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