http://www.thedailybeast.com/blogs-and-stories/2010-01-21/obamas-half-baked-bank-reform/p/
Obama's Half-Baked Bank Reform
by Nomi Prins
January 21, 2010 | 10:40pm
Barack Obama Charles Dharapak / AP Photo Wall Street has already
figured out how to game the president’s proposal to reform the
banking system. Former Goldman executive Nomi Prins on how to stop
the trickery.
Seeing Paul Volcker, former Fed Chair and chairman of the Economic
Recovery Advisory Board, lord over President Obama yesterday as he
made his proposal to limit the scope and size of financial
institutions, it was easy to imagine him saying “I told you so.”
Volcker, after all, has been a long time advocate of slicing up
banks and prohibiting them from the majority of speculative
activities.
But as I called around New York and Washington yesterday, it
already seems that Wall Street has figured out ways to circumvent
the administration’s plan, which centers on “proprietary
trading”—risky bets the banks make for their own accounts.
These merged institutions will continue to divert their
capital—given to it by mom-and-pop depositors and cheap government
money—to trade, before using it to lend.
The cliff notes from the President’s Economic Recovery Advisory
Board chief economist Austan Goolsbee on yesterday’s press call
were: A mandatory ban to prohibit proprietary trading (but not all
trading) by firms that own banks. Regulators would prevent
commercial banks from owning hedge or private equity funds, and
limit non-client related trading. There would remain no limit on
investment banks not designated bank or financial holding
companies. Regulators could constrain the size of banks, but not
break them up. Most important, there would be no return to
Glass-Steagall, which divided commercial and investment banks.
The importance of the latter became clear to me as I talked to DC
policy advisers yesterday, who had already gotten an earful from
Wall Street lobbyists—touch proprietary trading if you must, and
leave everything else alone (i.e., no Glass-Steagall). Prop
trading, in other words, would be Wall Street’s sacrificial lamb.
For a simple reason: They can get around it.
Banks have mucked up their financial disclosures so much that it’s
already near impossible to tell how much banks are making from
risky trading, much less how much trading is uniquely
“proprietary,” versus how much can be classified as
customer-driven or used for hedging purposes, which Obama’s rules
would allow. Bank of America, for example, has its fixed income,
currency and commodities trading figures merged together, making
it impossible to see the contribution of Merrill Lynch’s sizeable
trading activities, as well as the line between proprietary and
possibly customer-oriented trading. Other banks are even more
Byzantine. You can’t limit something that isn’t fully disclosed or
can be camouflaged on the books.
Plus, in a crisis, it’s hard enough to price securities, let alone
figure out which trading distinction they possess. At last week’s
Financial Crisis Inquiry Commission, JPM Chase CEO, Jamie Dimon
said, “It’s not always possible to evaluate positions…Although we
are a proponent of fair value accounting in trading books, we also
recognize that market levels resulting from large levels of forced
liquidations may not reflect underlying values.”
If “it’s not always possible to evaluate positions,” the notion of
evaluating which ones are customer-driven and which are
proprietary goes out the window. These firms will just call
everything customer driven and alter book distinctions accordingly.
Bringing back Glass-Steagall would force a distinction of
commercial banks with access to federal support from those that
just call themselves banks, but are in reality Wall Street
gambling parlors. Done right, Goldman Sachs and Morgan Stanley
would have to give up their commercial bank status to continue
doing the trading-oriented business they do. Bank of America might
be forced to spin off Merrill and JPM Chase may have to chuck the
Bear business and part of its “leading global” investment bank
business to adhere to new restrictions.
Without such a move, these merged institutions will continue to
divert their capital—given to it by mom-and-pop depositors and
cheap government money—to trade, before using it to lend. When the
markets go up, trading is more profitable and as we’ve seen in
bank earnings reports this year, banks beef up trading activities
where they can, to offset consumer and commercial credit losses.
And it works in reverse: If their commercial and investment
businesses remain intertwined, banks will extract costs, such as
the $90 billion over-10-year tax Obama proposed last week, from
the customers’ pockets. Banks would still be inclined to use their
capital to trade (which is a more capital-intensive endeavor than
deposits and lending).
Risk is risk whether it's called propriety trading or comes from
the customer-trading business. True systemic risk reduction
requires dividing out all trading activities from within a firm
that also does deposits and lending. That requires a resurrection
of a true Glass-Steagall barrier, not a bunch of stuff that sounds
like it gets partly there.
Nomi Prins is author of It Takes a Pillage: Behind the Bonuses,
Bailouts, and Backroom Deals from Washington to Wall Street
(Wiley, September, 2009). Before becoming a journalist, she worked
on Wall Street as a managing director at Goldman Sachs, and
running the international analytics group at Bear Stearns in London.
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