Big banks are today's designated villains, widely blamed for creating
the financial crisis and criticized for sopping up government bailout
money and then indulging in a new orgy of extravagant bonuses. To
prevent the banks from acting carelessly and taking excessive risk,
President Obama has proposed restricting bank activities, like
prohibiting them from trading for themselves and limiting the size of
These proposals, made late in January of this year, come on top of
others: a $90 billion tax over 10 years on the 50 largest banks to pay
back bailout money; efforts to assure executive compensation doesn't
encourage excessive risk taking; and a proposal for a new consumer
protection agency, among others.
"While the financial system is far stronger today than it was one
year ago, it is still operating under the exact same rules that led to
its near collapse," Obama said in announcing his proposals. He went on
to tap into populist, anti-bank sentiment, noting the banks are making
record profits while refusing to lend to small businesses, that they are
charging high credit card rates and failing to "refund taxpayers for
the bailout." He added that it was "exactly this kind of
irresponsibility that makes clear reform is necessary."
But would the latest proposals, including the "Volcker Rule" named
for their champion, Paul A. Volcker -- the former Federal Reserve
chairman who is one of Obama's chief economic advisors -- really get at
the causes of the recent financial crisis? The Volcker Rule, including
the proprietary-trading restriction, has many high-profile supporters.
But we at Blackhawk think it misses the mark by focusing attention on
the now-blurred distinction between commercial banks, which take
deposits, and investment banks, which trade on their own accounts and
underwrite stock and bond issues.
I personally believe that all the bank proposals of the Obama plan
have nothing to do with why the crisis occurred – absolutely nothing.
The crisis originated in the non-bank financial firms, firms like
American International Group, an insurer, and Lehman Brothers, a
financial-services firm that did not engage in commercial banking.
Volcker has been pushing his ideas for at least two years. I am
afraid the plan has always struck me as nostalgia for the 1980s.... It
has little to do with the current crisis if any.
The proposals, which were announced early this year would prohibit
institutions that take deposits -- commercial banks or firms that own
them -- from making their own bets on stocks or other financial
instruments, including derivatives. They would not be allowed to invest
in or sponsor hedge funds or private equity funds. Obama also would
limit each bank's share of total liabilities in the marketplace, much as
regulations limit any single institution's market share of deposits.
The proposals still have to be fashioned into Congressional bills, but
they dovetail with a risk-reducing bill which passed the House last
December. That legislation's prospects in the Senate are iffy, largely
because of opposition from Republicans as well as some conservative
Critics think institutions that trade on their own accounts are
essentially gambling with depositors' money, potentially spreading
financial contagion when bets go wrong. Deposit-taking institutions rely
on a public safety net, such as FDIC insurance that makes customers
whole if a bank goes under. The Volcker Rule is based on the premise
that if the public is at risk, it can be invoked to curb risk taking.
Under Obama's proposal, the commercial banks would continue to be
allowed to trade on customers' behalf.
A recent article in The New York Times notes that many current Wall
Street leaders oppose the Volcker Rule, but that some of their
predecessors and other finance giants support it. The latter group
includes financier George Soros, former Treasury Secretary Nicholas F.
Brady, former Citigroup co-chairman John S. Reed, former Wall Street
executive and Securities and Exchange Commission chairman William
Donaldson, and John C. Bogle, founder of Vanguard Group, the mutual fund
Amid the Depression, Congress passed the Glass-Steagall Act,
separating commercial and investment banks. This restriction was
gradually whittled down until Glass-Steagall was repealed in 1999. In
recent years, Wall Street's behemoths have engaged in both commercial
and investment banking activities, even betting -- and sometimes losing
-- vast sums on complex, poorly understood derivatives and
A number of them, such as Citigroup, which was heavily involved in
the mortgage-derivatives market, have required costly government
bailouts in the financial crisis. The Volcker Rule is a small step
toward restoring some separation between commercial and investment
banking. It targets institutions like Citigroup, Bank of America,
JPMorgan Chase, Wells Fargo and Goldman Sachs.
Some of Obama's proposals, including the $90 billion tax, are
sensible. The tax seems perfectly reasonable .... The banks should have
to pay that. It is a fact that states often impose special charges on
insurers after a company fails. The idea of a tax on survivors to make
up for losses is not a completely-out-of-the-question type of concept.
It's done at the state level all the time.
But, I still believe that the banking proposals miss the big picture.
The centerpiece of the proposals, which involves restricting risky
practices at commercial banks, would be hard to implement effectively
for the simple reason it would be nearly impossible to distinguish
between trades a firm does for its own benefit and those it executes for
customers. What looks like a trade done in a firm's proprietary account
can be part of hedging strategy tied to a customer's activities. I'm
still totally scratching my head on that.
It is a further fact that the proposals do not offer a remedy to the
problem of institutions deemed too big to fail, or those whose collapse
might potentially take the economy down with them. It's all very well to
say that once Goldman Sachs is no longer a bank holding company, it
will no longer be bailed out. This assertion has no credibility in the
wake of the bailouts of Bear Stearns, Fannie Mae and Freddie Mac and
AIG. Each of these institutions received government help even though
they were not commercial banks.
These proposals don't address the underlying problems. A crucial
factor that led to the crisis was the Federal Reserve's
low-interest-rate policy and global imbalances, such as the build-up of
currency reserves in Asia and the budget deficit in the United States.
These proposals do absolutely nothing to address those issues.
I strongly believe a much better system is needed for recognizing
risks building up in the system, such as those created by
mortgage-backed securities that contributed to the recent crisis. We
have to have proper capital requirements that reflect the macro risk
posed by these securities, and the loans that financial institutions
hold. Hence, the Federal Reserve should play a stronger role in
monitoring the ebb and flow of risk in the markets. The Federal Reserve
should in fact be more alert to the macroeconomic risks in the system,
and warn the financial intermediaries when those risks have increased.
Every Wall Street veteran out there knows that mortgage-backed
securities, exotic derivatives and risky trading were not so much the
cause of the financial crisis, as many people believe, but the result of
two major underlying problems.
The first was the Federal Reserve's policy of keeping interest rates
extraordinarily low to help the U.S. recover from the technology-stock
debacle at the start of the decade. The second was the huge build-up of
financial reserves in China and other Asian countries, which created an
enormous appetite for debt-related securities. Together, these factors
caused a drop in lending standards and fed a housing bubble in the U.S.
and some other countries. When the bubble collapsed, debt-related
securities plummeted in value, sparking the credit crisis.
There has been a tremendous focus on the private sector and what the
private sector did wrong in terms of taking excessive risk. However, if
the basic cause of the crisis was the real estate bubble and central
banks played a role in creating that, it is really the public sector
that took the main risks. Part of the problem is the tradition of
independence at the Federal Reserve, which allowed Alan Greenspan, the
Fed chairman at the time, to dominate rate-setting decisions. I believe
it is desirable to have a better system of checks and balances to
restrain risk taking in the public sector.
One possible reform would modify the Federal Reserve's function to
place greater emphasis on the need to maintain financial stability.
Currently, the Fed's chief emphasis is on maintaining a balance between
inflation and economic growth. Why not also creating a "Financial
Stability Board" with a staff and resources independent of the Fed and
focused on threats to financial stability. Several representatives of
this board would sit on the Fed's Open Market Committee, which sets
To moderate the problem of global imbalances, the governance
structure of the International Monetary Fund -- a source of emergency
funds to troubled countries should be changed to give Asian countries a
larger role. If these countries were assured fairer treatment when they
run into trouble, they would have less need to self-insure by
maintaining large reserves. That would reduce the fuel to feed excesses
like the housing bubble in the West.
Further, the Volcker Rule does not address the most important need: a
way to shut down failing institutions in an orderly fashion, the way
the Federal Deposit Insurance Corp. does with failed commercial banks.
We need to have a plan for dismantling non-bank financial intermediaries
if need be.
That could be done by giving the government authority to take over
non-bank institutions the way it does with commercial banks, without
waiting for a shareholder vote. This can be tricky with international
institutions, since some countries could suffer more than others. This
could be resolved by requiring that financial institutions use
subsidiaries to operate in foreign countries rather than by establishing
branches across borders. The subsidiaries would be regulated by the
countries in which they operate.
The fundamental problem with the recent bank proposals is that they
use a piecemeal approach rather than helping build an international
strategy. They haven't got their hands around the issue as a whole and
this is very disappointing to say the least.
Looking forward to doing business with you and to continue being your
resource for deals, capital, relationships and advice.
Your feedback as always is greatly appreciated.
Thanks much for your consideration
Ziad K Abdelnour