President Barack Obama recently announced his intention to ask Congress to require banks to choose between engaging in proprietary trading—trading for their own investment accounts, not those of clients—or holding insured deposits. Meanwhile, legislation has been introduced in Congress that would reinstate the Glass-Steagall Banking Act of 1933.
The “Volcker Rule”
Under the proposal—which Obama labeled the “Volcker Rule,” after former Federal Reserve Board Chairman Paul Volcker, now head of the President's Economic Recovery Advisory Board, who championed the changes—banks would be required to choose between engaging in proprietary trading—trading for their own investment accounts, not those of clients—or holding insured deposits.
Depository institutions' holding companies also would be barred from advising or investing in hedge funds or private-equity firms, unless the activity was related to client business. Other “risk-prone activities” also could be regulated.
The proposal also would restrict funding. Currently, depository institutions are barred from acquiring another depository institution of the transaction would result in a firm holding more than 10 percent of the nation’s insured deposits—although firms are allowed to exceed the 10 percent figure through internal growth. The proposal would extend the limit to a broader range of firms to include non-deposit funding, although the specifics on the cap still are being developed.
The proposal would close the Federal Reserve’s discount window to firms that do not hold insured deposits. The discount window and other lending facilities were opened to non-bank firms in 2008 and 2009.
Reaction to the proposal from industry trade groups was mixed. The Independent Community Bankers of America applauded the proposal, saying it had warned against the over-concentration of the financial services industry for two decades.
The Financial Services Roundtable, which represents 100 of the largest integrated financial services companies providing banking, insurance, and investment products and services, said the proposal would “restrict lending, increase risk, decrease stability in the system, and limit our ability to help create jobs.”
Commercial banks also weighed in, claiming that their proprietary lending did not cause the current financial crisis, which they attribute to the risky practices of investment banks and poor lending decisions. They argued that, rather than creating a brick wall in a globalized financial system, policymakers should concentrate on crafting better risk-management standards.
Congressional Reaction
U.S. House Committee on Financial Services Chairman Barney Frank (D-Mass.) said he would support the proposal but that it must be phased in gradually, so as to limit the disruption to financial markets. Frank said, “I will be supportive of this with a time frame of no less than 3 or 5 years before it gets done… To have all these sales at the same time would be a fire sale and I can't support that.”
Retiring Sen. Christopher Dodd (D-Conn.), chair of the U.S. Senate Committee on Banking, Housing, and Urban Affairs, was noncommittal on the prospect of including the proposal in the financial regulatory reform legislation he has been carefully crafting with Sen. Richard Shelby (R-Ala.), the committee’s ranking member. Shelby—who voted against Gramm-Leach-Bliley—said he would like Dodd to hold a hearing on the proposal.
Glass-Steagall Reinstatement
While the Obama proposal would stop short of reinstating the original Glass-Steagall restrictions that were in place from 1933-1999, a bill—the Return to Prudent Banking Act of 2009—has been introduced that would reinstate the Glass-Steagall Banking Act of 1933.
Glass-Steagall prohibited commercial banks from engaging in investment banking until it was repealed in 1999 by the Gramm-Leach-Bliley Act, which ushered in an era of financial deregulation and a rise of conglomerates engaged in banking, insurance, and proprietary trading.
The Return to Prudent Banking Act of 2009 would reinstate the prohibition against commercial banks engaging in investment banking and insurance activities.
The Senate version of the bill (S. 2886) was introduced by Sens. Maria Cantwell (D-Wash.) and John McCain (R-Ariz.) and is cosponsored by Sens. Barbara Boxer (D-Calif.), Russell Feingold (D-Wisc.), Tom Harkin (D-Iowa), Edward Kaufman (D-Del.), and Bernie Sanders (I-Vermont).
The House version of the legislation (H.R. 4375) was introduced by Rep. Marcy Kaptur (D-Ohio) and has five bipartisan cosponsors: Reps. Peter DeFazio (D-Ore), Jay Inslee (D-Wash.), Walter Jones (R-N.C.), Jim McDermott (D-Wash.), and John Tierney (D-Mass.).
At a press conference announcing the bill’s introduction, McCain said, “Under our proposal, too-big-to-fail banks would be forced to return to the business of conventional banking, leaving the task of risk taking or management to others.”
The president of the Independent Community Bankers of America, Camden Fine, attributed the introduction of the legislation to a “growing realization” in Congress that the original repeal may have been a mistake. Fine was quoted as saying, “We cruise along for 80 years without a major calamity infecting the entire financial system and then less than eight years after the repeal of Glass-Steagall we have a financial meltdown in this country. That’s no accident.”
