Obama to Propose New Rules on Banks’ Size, Trading

Date: Thursday, January 21, 2010
Author: Nicholas Johnston and Julianna Goldman, Bloomberg

President Barack Obama will offer proposals to limit financial institutions’ size and trading activities as a way to reduce risk-taking, an administration official said.

Obama will announce the rules today at 11:40 a.m. in Washington after meeting with former Federal Reserve Chairman Paul Volcker at the White House. The proposals will be part of an overhaul of regulations and will specifically address firms’ proprietary trading, the official said yesterday on the condition of anonymity.

Obama is renewing his focus on economic issues, tapping into voter anger about the struggling economy, taxpayer bailouts and growing bank profits at a time of 10 percent unemployment and a federal deficit that rose to $1.4 trillion last year.

The proposals could affect trading at some of the nation’s largest banks, including New York-based Goldman Sachs Group Inc., Morgan Stanley and JPMorgan Chase & Co., said Frederic Dickson, chief market strategist at D.A. Davidson & Co. in Lake Oswego, Oregon. Banks conduct proprietary trading for their own benefit, not for that of their clients.

“It is an obvious target,” Dickson said. “It has been a highly profitable business for those firms that have superior platforms. Whatever the details of the restrictions, it will draw Wall Street’s attention.”

Obama in June proposed an overhaul of U.S. financial regulations to fix lapses in oversight and excessive risk-taking that helped push the economy into a prolonged recession.

Fee on Companies

Last week the president announced a plan to impose a fee on as many as 50 financial companies to recover losses from the federal government’s Troubled Asset Relief Program. It would be imposed starting June 30 on companies such as New York-based Citigroup Inc. and American International Group Inc. and Bank of America Corp. based in Charlotte, North Carolina.

“We’ve got a financial regulatory system that is completely inadequate to control the excessive risks and irresponsible behavior of financial players all around the world,” Obama said in an interview with ABC News yesterday.

“People are angry and they’re frustrated,” Obama told ABC. “From their perspective, the only thing that happens is that we bail out the banks.”

Voter anger helped Republican Scott Brown win the late Edward Kennedy’s U.S. Senate seat in Massachusetts this week, giving Republicans the ability to block Obama’s top legislative priority, a health-care overhaul. The Massachusetts seat had been held by Democrats for more than 50 years.

U.K. Plans

The proposed U.S. rules could limit activities of banks such as Goldman, the most profitable investment bank in Wall Street history. Goldman reaped more than 90 percent of its pretax earnings last year from trading and so-called principal investments, which include market bets on securities and stakes in companies.

Goldman reported its quarterly earnings today, beating analysts’ estimates as the company slashed the percentage of revenue allocated to compensation. Morgan Stanley reported yesterday, and JPMorgan published its results last week.

In Britain, the Financial Services Authority last month published plans to make banks scale back proprietary trading, where a firm trades securities and other financial instruments with its own money rather than for customers. Under the rules, banks would have to put up as much as 29 billion pounds ($47 billion) of extra capital to cover potential trading losses.

‘Regulatory Arbitrage’

Bankers say additional regulation may threaten both their industry and a recovery in the economy. Marcus Agius, chairman of Barclays Plc, Britain’s second-biggest lender, said today he’s concerned that regulation imposed by national governments may jeopardize competition among lenders.

“In all of this, there’s the whole question of an international level playing field,” he told a London conference. “It’s something people say they believe in, but we’re seeing elements of regulatory arbitrage. We’re in the early and fragile stages of an economic recovery, and what we don’t want is to kill that with an excess of regulation.”

Volcker, chairman of the President’s Economic Recovery Board, has criticized as “reform light” the financial industry’s efforts to weaken financial regulation proposals in Congress.

A year ago, Volcker issued a report from the Group of Thirty, a panel of former central bankers, finance ministers and academics, calling for separation between commercial banks and businesses that engage in speculative risk-taking such as hedge funds and proprietary trading.

‘A Bad Dream’

“Some market participants, possibly some in this room, seem to be suggesting that the events of the past couple of years were like a bad dream -- a truly unsettling bad dream, but nonetheless something that in the cold light of day need not require a really substantive change in the structure of markets or corporate lifestyle,” Volcker told an audience that included bankers Jan. 14.

Four U.S. institutions -- Bank of America, San Francisco- based Wells Fargo & Co., JPMorgan and Citigroup -- held 35 percent of the country’s deposits on June 30, compared with 28 percent by the four biggest two years before, according to the Federal Deposit Insurance Corp. and the Federal Reserve.

‘Inappropriate’ Areas

During last week’s speech at the Economic Club of New York, Volcker warned that “some areas of finance, as well as ownership ties with commercial firms, are inappropriate for banking.” He specifically cited hedge funds, private equity funds and proprietary trading.

“The point is that they present added risk and virtually unmanageable conflicts of interest with more essential customer relationships,” Volcker said.

John S. Reed, the former co-chief executive officer of Citigroup, said he regrets helping engineer the merger that created the bank.

“I’m sorry,” Reed said in an interview last year. U.S. lawmakers were wrong in 1999 to repeal the Depression-era Glass- Steagall Act, he said. The act required the separation of institutions involved in capital markets from those engaged primarily in traditional customer services, such as taking deposits and making loans.

Reinstating Glass-Steagall

Republican Senator John McCain of Arizona and Democrat Maria Cantwell have proposed legislation to reinstate the Glass- Steagall law as a way to stem the rise of banking conglomerates such as Citigroup, JPMorgan and Bank of America that are active in retail banking, insurance and proprietary trading.

The Securities and Exchange Commission under Chairman Mary Schapiro is beginning its own review of financial markets, including an examination of so-called high frequency trading, in which professional investors execute orders in milliseconds to capture tiny price discrepancies. The strategies make up more than 60 percent of all U.S. stock transactions, according to New York-based research firm Tabb Group.

The House of Representatives passed a package of new financial rules in December while the Senate continues to work on legislation that has the support of Republicans and Democrats.

The two lawmakers leading the regulatory reform effort, Senate Banking Committee chairman Christopher Dodd and House Financial Services Committee chairman Barney Frank, as well as former SEC Chairman William Donaldson will join Obama for the announcement.

To contact the reporters on this story: Nicholas Johnston in Washington at njohnston3@bloomberg.net; Julianna Goldman in Washington at jgoldman6@bloomberg.net