Will bank reform control risks?

Obama's proposals may do little to improve financial system safety

WASHINGTON: President Barack Obama's proposal to impose limits on commercial banks may win him support on Main Street and shake up Wall Street without doing much to make the financial system safer overall.

The plan, which is still lacking in details and must be approved by Congress, aims to make the banks more secure by forcing them to minimize the trading they do on their own account and give up their stakes in hedge funds and private equity firms. "It's the right direction," said Henry Kaufman, a former vice-chairman of Salomon Inc.

The danger is that such risky activities could simply migrate to big non-bank financial institutions, leaving the system as a whole no better off. Banks also might try to make up for the loss of profits from proprietary trading by lending more to risky borrowers such as real estate developers, threatening the federal safety net, said Martin Baily, a former White House economist now with the Brookings Institution in Washington.

"Beware of unintended consequences," said Robert Litan, vice-president of research and policy at the Kansas City-based Kauffman Foundation, and a former Clinton administration budget official. "This could have perverse effects on risk-taking."

The proposals highlight the difficulties the administration has faced in dealing with institutions that have grown so big and risky that their failure could rock the financial system.

Until that's resolved, the US will be forced to use taxpayer money to rescue failed firms or risk the same sort of global financial panic that occurred in the wake of Lehman Brothers Holdings Inc's collapse in September 2008.

The president's proposals "would require a shrinkage of the profit-making activity of some of these institutions", said David Nason, a former Treasury assistant secretary. "If implemented it would be a significant change."

Goldman Sachs generated at least 76 percent of 2009 revenue from trading and principal investments and gets the "great majority" of transactions from customers, according to Chief Financial Officer David Viniar. About 10 percent of the New York-based firm's revenue comes from "walled-off proprietary business that has nothing to do with clients", he said.

New York-based JPMorgan derived $9.8 billion of revenue from principal investments in 2009, or 9.8 percent of the firmwide total, according to its financial statements. The prior year, the bank lost $10.7 billion on principal investments.

Obama, who unveiled the proposals at the White House, also called for legislation to limit how big financial institutions can get by putting a ceiling on the share of the market they're allowed to hold.

"The American people will not be served by a financial system that comprises just a few massive firms," the president said, with former Federal Reserve Chairman Paul Volcker, a advocate of such steps, at his side.

The proposal was reminiscent of Glass-Steagall, the 1933 act that separated commercial and investment banking and was repealed in 1999.

The Depression-era law was stricter than the president's proposal, which would allow commercial banks to continue some investment-banking activities like underwriting stock offerings, merger-and-acquisition advice and asset management.

The plan to rein in banks was Obama's second this month. On Jan 14 he proposed to tax the biggest financial firms in order to get back "every single dime" of taxpayer money used in bailouts. Obama's latest broadside came just hours after Goldman Sachs, the most profitable securities firm in Wall Street history, reported record earnings that beat analysts' estimates.

Some financial experts see a political motive. "The Democrats are trying to come up with a theme that appeals to the public," ahead of November congressional elections, said Gary Dewaal, group general counsel in New York for Paris-based Newedge Group, which calls itself the world's largest futures broker.

Bloomberg News

(China Daily 01/23/2010 page10)