Before announcing the second step, a week after the first, Mr. Obama, in a feisty mood ready for “a fight,” accused banks, as he has done repeatedly, of taking “huge, reckless risks in pursuit of quick profits and massive bonuses” and causing the global financial crisis. He argued that it was time to close the loopholes that had enabled banks to trade risky financial derivatives, such as credit-default swaps, which landed them in deep trouble.
To close these loopholes, he made two proposals aimed at limiting the scope and scale of banks. First, banks, if they were to collect government-insured deposits and access the Fed’s discount window, would no longer be permitted to own, invest or sponsor hedge funds, private-equity funds or engage in proprietary trading for their own accounts. Labeled the Volcker Rule, after a former Fed chairman and the head of Mr. Obama’s Economic Recovery Advisory Board, this would only partially revive the Glass-Steagall Act of 1933, repealed in 1999. This law was enacted after the Great Depression, as part of the New Deal, against universal banking by separating commercial and investment banking. Second, to prevent further consolidation of the financial system and to fight the too-big-too-fail syndrome, banks would be subjected, besides the existing caps on their deposits to no more than 10 percent of the national deposits, to limits on non-deposit funding such as short-term borrowing in financial markets. This second proposal, which would stop the growth but not shrink the current sizes of banks, is still lacking in details. Both proposals seem to have taken big banks by surprise.
Last Tuesday, the International Monetary Fund (IMF) released its Global Financial Stability Report (GFSR) Market Update, titled “Financial System Stabilized, but Exit, Reform, and Fiscal Challenges Lie Ahead,” which concluded, after stressing the complexities of achieving “a correct balance between safety and dynamism,” that “for regulatory reform to be successful, micro- and macro-prudential regulations will have to complement one another and help to effectively mitigate systemic risks.” But how will that happen? The major stumbling block to effective financial regulatory reform, which has to be globally coordinated and market-driven, is the disagreement between the US and the European countries -- especially France and Germany, which would be loath to give up universal banking -- about its tools, scope and scale. This was stressed by both the statement issued last week in Washington by the Institute of International Finance, the global association of financial institutions and the remarks of IMF Managing Director Dominique Strauss-Kahn in Davos. We have to wait and see whether the next G-20 summit in June will succeed in overcoming the fundamental disagreements among the financial regulators themselves.
