Wall Street’s Chickens Come Home to Roost

President Obama yesterday fired the first salvo in what is going to be a bruising battle to rein in Wall Street. More than a year after the financial crisis brought the economies of the developed world to its knees, its been business as usual, perhaps even a little better than usual, for the financial sector.

Well, no longer. The President in a hard hitting speech blamed Wall Street for financial crisis and the ongoing economic slump. He then laid out what he called the Volcker Rule, as a nod to Paul Volcker, former Fed chief, who has suddenly become very influential. While the details were scant, the thrust of the Volcker Rule was two-pronged.

One, separate the deposit taking banking business from risky proprietary trading, hedge funds and private equity.

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.

Two, limit the size of all financial firms by preventing consolidation beyond a point.

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.

No doubt, there is politics behind this. After a very important loss in the Massachusetts senate race, the healthcare bill is in trouble. Financial reform is popular and the Republicans will find it very difficult to fillibuster it. On healthcare, he wasn’t driving, either by choice or out of necessity, Congress was. Now, he can take back the initiative on something that is popular and substantive.

There are no details yet, but needless to say, the financial media and the blogosphere are all aflutter. The Financial Times today had about a third of the paper devoted to this issue. Most commentators are saying “What took you this long?”. But there is criticism:

On thread of criticism is that the proposal doesn’t do enough. The crisis was not centered on banks. All financial players were involved. Toxic assets and leverage created the danger that there would be a systemic meltdown if one or two large financial firms went under. Separating risky businesses from deposit taking bank protects the banking customers, but that doesn’t address the systemic risk issues. Limiting the size of all financial firms by just preventing further consolidation is thought to be too weak. Although it would be difficult to think of any other practical solution.

Another problem is that proprietary trading is “in the eye of the beholder”. It is (or can be made) indistinguishable from trading for clients. So how do you separate it from the deposit taking bank?

There is also the matter of international banks who are not subject to US law in this matter but operate in the US. Finance is global now and when you talk about systemic risk it is not limited to the US only. But this may be less of an issue. The Conservative party in the UK which is expected to win the next election has already said that they favour legislation similar to what Obama has proposed.

And then there are those who say that the Volcker Rule will never see the light of day. Bills are passed in the Congress and Senators need a lot of money to get elected. And Wall Street has that money.

To top it all, yesterday the Supreme Court, struck down a 63 year old limit on corporate spending on elections. The coincidence is quite ironical. No wonder the President is gearing up for a fight

So if these folks want a fight, it’s a fight I’m ready to have.


  1. Krishna says:

    Obama is clearly missing the ball (just as in his foreign policy initiatives) if he isn't upto shrinking the size of Goliath financial firms. I see more of regulatory reform than structural rewiring that's necessary to obviate future meltdowns. For eg. why can't he ban naked bets like CDS (where neither the issuer nor the bondholder has any stake in the underlying transaction) that broke the back of AIG altogether? By these half-hearted staccato initiatives, I think he's just trying to save his (larger than life) face that he seeded in the minds of people during the campaign. Up there at the altar, he's confused as hell like any other President.


  2. Krishna says:

    I recall the popular `cram down’ provision Obama used in the campaign – giving power to bankruptcy judges to adjust mortgages that are deep underwater – which is something every bank should easily agree because at least they can expect to recover their capital if the borrower has his home than to force a foreclosure and take the hit in their balance sheets. But the banks deployed their lobbyists, and this vital though totally inadequate measure was defeated in May. The Obama administration sat quietly by. The President can no longer afford to be the slow learner of Washington ways. He should by now know that shame doesn’t exist for Wall Street. Trillions of $ of tax payer money down their throats neither dissuade them from lobbying again on Capitol Hill nor would that leave Congress members less unsympathetic to their pleas.


  3. MrDalal says:

    They'll just rename it to something else, or have a convulted way of doing it. (proprietary trading).

    The real issue is something obama cannot fix. or for that matter, nobody can fix. its the whole market setup, with a genius term used to explain it – casino capitalism. now if u can double your money in 2 months, who will not take a chance? take that possibility out, and we'll all be good. – but can anyone do that? shortlist all factors enabling short term trading and remove them one after the other – ?


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