The Proposed New Bank Regulations

I only caught the beginning of the president's remarks yesterday morning before he described his proposals for bank regulation. What I heard was disconcerting, as, in his usual manner, the president completely misrepresented the nature and causes of the recent financial sector turmoil.


As his party's Congressional members also conveniently forget, it was Fannie Mae's and Freddie Mac's mandates to securitize mortgages to low income borrowers that got the ball rolling. Commercial and investment banks only joined the party that was started in Congress and by two prior administrations.


Never the less, when I turned to that evening's online edition of the Wall Street Journal for the details of the new proposals, here is what I read,


"The White House wants commercial banks that take deposits from customers to be barred from investing on behalf of the bank itself—what's known as proprietary trading—and said the administration will seek new limits on the size and concentration of financial institutions.
President Obama proposes new rules designed to restrict the size and activities of the nation's biggest banks.

Under the White House's proposed bank regulations, banks will be forced to choose between taking deposits and trading.

Administration officials said the new rules would force major institutions from J.P. Morgan Chase to Bank of America to decide the direction of their business. Banks shielded from risk through federal-deposit insurance, or aided in financial crises by low-interest loans from the Federal Reserve Board, would no longer be allowed to engage in trading unrelated to their customers' interests, one senior administration official said.

Under the proposed rule, commercial banks would be prohibited from owning, investing in or advising hedge funds or private-equity firms. Bank regulators would not be simply given the discretion to enforce such rules. They would be required to do so.


"You can choose to engage in proprietary trading, or you can own a bank, but you can't do both," the official said.

Administration officials said they also want to toughen an existing cap on bank market share. Since 1994, no bank can have more than 10% of the nation's insured deposits. The Obama administration wants that cap to include non-insured deposits and other assets. The White House released no information on what those other assets might be, saying officials would work closely with Congress to set tougher caps designed to prevent the further concentration of financial industry markets within a few behemoths."



The good news is that the quasi-Glass-Steagall portion of the proposal is very sensible. It mirrors, nearly identically, what my friend B prophesied over a decade ago, in 1996. It also clearly embodies Paul Volcker's desire to separate financial risk-taking activities other than basic loans from any federally-insured financial activities.


If large banks such as Chase and BofA have to spin off some of their businesses, so be it. It's been done before. If Goldman has to forego a federal safety net, that's fine, as well. Next time, they'll be allowed to fail, as they should have been in 2008.


The part of the proposals dealing with the size of insured deposit-taking institutions is, I believe, now moot. Once you have deposit insurance, and restrict such a mundane bank's activities to basic consumer and business loans, size really is irrelevant with respect to risk. Any bank failure will just involve paying depositors from funds available, and insurance, selling loans, and closing the bank. It doesn't really matter how large the institution is.


What the administration confuses is current size of financial institutions doing proprietary trading and underwriting, rather than large, plain vanilla commercial banking.


The bad news is that these proposals, or at least the first one, are unlikely to be passed into law.


I don't know all the details of the proposals, and there may be some 'resolution authority' language which makes them unfair in terms of taking private property. But a return to some sort of investment and commercial banking separation would be a healthy thing.


Among the criticisms of the proposals that I heard last evening was a very appropriate one by Virginia Republican Representative Eric Cantor. Cantor noted that the proposed legislation omits any mention of the two GSEs, Fannie and Freddie, which kicked off the entire financial sector meltdown.


Failure to include those risk-taking institutions in the proposals makes them totally incomplete and probably doomed to being ineffective. Without some recognition of the mistakes that Congress made with those entities, no financial sector regulatory "reform" is going to work any better than what we've already got.


If we can't get Washington to stop its denial of how the recent excesses began, we're never going to get anywhere with proposed solutions.