Reports are out that today President Barack Obama will announce new proposals to limit the size and risk-taking ability of the largest banks immediately following an optically convenient meeting with adviser and former Fed Chair Paul Volcker. Volcker has been advocating for these changes for some time; after initially calling for a return to Glass-Steagall, he shifted position to argue for a 21st-century Glass-Steagall.What does that mean? New limits on how banks can use FDIC-insured funds to prevent speculation with money guaranteed by the government, limits on proprietary trading desks within firms that take advantage of the bank's special knowledge to invest its own capital, and restrictions on investments in hedge and private equity funds. What this doesn't entail is any split between commercial and investment banking, which was the original Glass-Steagall's purpose, on the grounds that "mixed" banks are not seen as major factors in the crisis, while banks with huge leverage or those whose internal hedge funds failed, like Bear Stearns, did attract trouble. The goal of this policy is to regulate more strictly those business lines, like proprietary trading, that increase a bank's size and risk more quickly than financiers and regulators can manage either.
Without more detail than is in these three articles this proposal is hard to evaluate, but if it really restricts banks' ability to invest in highly leveraged speculation, then this is a major step in the right direction. If, on the other hand, it relies on procedural firewalls, its hard to see the reforms amounting to much. I'll update as more information becomes available. Politically, this is the populist/financial reform focus that Obama promised for the New Year and which has gotten all the more important since the victory of Republican Senator-elect Scott Brown on Tuesday. Despite my happiness at seeing Obama shift to my favorite issue, I'm not sure this announcement bodes well for the future of health care reform, which is where the president ought to be focusing his attention today if he wants to pass his bill.
Quick sidenote: My mind was blown to see the WSJ story include this line:
If investors believe the new rules could take effect, they could sell off the shares of most of the big financial stocks in the belief these companies would be facing years of turmoil and potentially lower profits.
They could have just as well said that investors would buy more shares in the belief that these companies won't crash if they become more stable, but that would be saying something positive about the plan. Noam Scheiber's argument about bias in the news pages seems more and more spot on.
-- Tim Fernholz
