10-01-23 WSJ - A return to sanity in banking Commentary: Obama bank plan is a response that fits the crisis

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Jan. 21, 2010, 4:27 p.m. EST · Recommend (16) · Post:  

A return to sanity in banking

Commentary: Obama bank plan is a response that fits the crisis

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By David Weidner, MarketWatch

NEW YORK (MarketWatch) -- Goodbye Wall Street -- and good riddance.

The sweeping reform President Barack Obama unveiled Thursday is short on detail, but in its broadest terms it aims to both preserve Wall Street's ability to take risk and strengthen the money system at the core of banking.

Finally, someone with the power to make it happen is talking about a response equal in scope to the system's failure.

Let's start with some of the problems of this vague plan. First, it's not Glass-Steagall, the 1933 legislative wall thrown up between commercial and investment banking. It's not a pure divide between investing and the credit system.

Second, not only is it short on details, the Volcker Rule unnecessarily takes aim at some targets that did not directly affect the banking system. In-house trading, hedge funds and private-equity businesses were not as nearly as much to blame as were derivatives, collateralized mortgage debt and credit-default swaps.

Reuters

U.S. President Barack Obama

But in cleaving these businesses from the big banks, the plan is the first serious recognition that these businesses can't co-exist under the same roof. It's a good start.

Regulators need to be certain the web of connections in the industry is cut. The collapse of one of these firms must not be able to knock the financial system off its pins.

The plan's immediate impact would be to scale down institutions. Banks would be broken up and the parts sold in offerings or to big investors.

Good for Wall Street...

The plan is good for Wall Street. Hedge funds, proprietary trading and private equity wouldn't be outlawed. They'd simply be required to operate alone. No more mortgages used as trading chips in the casino.

Theoretically, these parts of the financial system would be spun off or walled away from the marketplace that is central to the country's economic health. They could still make big bets and pay people as they see fit. Leverage would live. The only difference is that the government would not be responsible for their losses.

They will probably lose customers since commercial banks were willing buyers of Wall Street credit products, but the industry is wily and creative. If the stuff is worth anything -- or even if it isn't -- a broker will find a way to sell it.

...and for Main Street

The plan is good for Main Street. Under its terms, investment banks would no longer be able to stuff commercial-bank balance sheets with derivatives passed off as cash.

The big banks, like Bank of America Corp. (BAC 14.90, -0.57, -3.68%), Citigroup Inc.(C 3.25, -0.02, -0.61%) and J.P. Morgan Chase & Co., (JPM 39.16, -1.38, -3.40%) would not be able to squirrel away credit-default swaps and collateralized debt or pass off their own potential time bombs to unsuspecting investors.

It's a point the president recognized when he said "trading often puts banks in direct conflict with their customers' interests."

What's a bank

Eliminating those conflicts is where the Volcker Rule is aimed. The president and former Federal Reserve Chairman Paul Volcker have agreed that banks need to get back to banking. The approach outlined Thursday may not be perfect, but its intent is to make the money and credit market safe and limit the impact of shadow bankers.

Think about how our language has reflected the shift in financial services. For 60 years after Depression Era reforms were passed, there was a clear line: Banks made loans and took deposits and investment banks handled securities -- stocks and bonds and their derivatives.

In the decade after the Gramm-Leach-Bliley Act repealed those reforms, everyone and their day-trading cousins turned into bankers. Goldman Sachs Group Inc.(GS 154.12, -6.75, -4.20%) was a bank and so was Blackstone Group LP(BX 12.74, -0.68, -5.07%). Chrysler needs a loan? Cerberus Capital Management LP was there to help.

Now, the landscape could change, not to a simpler time but to a modern financial system that has learned from its mistakes.

Will it cause some short-term pain? Yes. But when you consider the pain caused by bringing the casino into the bank lobby, by comparison, the Volcker Rule won't hurt a bit.

David Weidner covers Wall Street for MarketWatch.