Barack Obama wanted a regulatory reform bill on his desk by the end of last year. It did not happen.
Rather than wait impatiently on the sidelines, the president on Thursday came up with new restrictions on Wall Street. which will further delay a bill – and add to the lobbying frenzy that surrounds it.
In a surprise move, Mr Obama adopted the ideas of Paul Volcker, the former Fed chairman, including a prohibition on commercial banks trading purely for their own account and a ban on owning hedge funds and private equity firms.
Tim Geithner, Treasury secretary, who is facing increased hostility from Democrats for not adopting punitive measures against Wall Street, had not taken up Mr Volcker’s proposals but did not fight the president’s decision.
Officials said banks would have to choose between owning an insured depository on one hand and owning proprietary trading operations or stakes in hedge funds and private equity firms on the other. They would, however, be able to continue proprietary trading related to their customers’ businesses.
Amid continuing uncertainty over the detail of the reforms, bank executives said they believed they could continue to own hedge funds as long as they did not invest their own funds.
Congress members on both sides of the aisle declined to commit to the Obama plan in interviews with the Financial Times. But Judd Gregg, a Republican member of the Senate banking committee, and Jack Reed, a Democratic counterpart, both said they had been attracted to Mr Volcker’s ideas during private meetings and were interested in considering them.
“This problem has not just been too big to fail, it’s been too big to manage,” said Mr Reed. “A lot of these organisations – they have the core of a bank but that is overwhelmed by very sophisticated subsidiaries and trading programmes.”
Mr Gregg said he was “willing to listen”. “I’m a little concerned that this, however, is less about financial reform and more about the politics of the day and an attempt to get a populist message going and use the banks as a whipping boy, which I don’t think is constructive.”
Rob Nichols, president of the Financial Services Forum, which represents leading institutions in Washington, said: “Trading, proprietary or otherwise, did not lead to the financial crisis.”
Although aides sought to distance the proposals from the Democratic defeat in Massachusetts, Mr Obama was spoiling for a fight on Thursday as he announced his second crackdown on Wall Street in two weeks following last week’s $90bn levy.
“I welcome constructive input from folks in the financial sector. But what we’ve seen so far, in recent weeks, is an army of industry lobbyists from Wall Street descending on Capitol Hill to try and block basic and common sense rules of the road that would protect our economy and the American people,” he said.
Mr Volcker has intellectual clout and political capital in Congress, which will be needed as the administration tries to gather support for its new proposals. Ironically, it was the Treasury and the White House – where Mr Volcker heads an economic advisory board – that had given his ideas the cold shoulder.
One man who had supported Mr Volcker and pushed a version of his plan through the House is Paul Kanjorski, a Democratic member of the House financial services committee, who passed an amendment allowing regulators to force a sale of a risky division.
Thursday’s move by Mr Obama removes the regulators’ leeway and Mr Kanjorski celebrated the toughened approach to what he called the “super core” of the industry’s problems.
But officials struggled to explain the link between this plan and the financial crisis. Senior Treasury officials have long argued that the crisis had very little to do with own-account gambling by banks with insured deposits. Many of the institutions that got into trouble were not traditional commercial banks.
Sceptics, including within the administration, said it would prove hard to put an end to the kind of own-account activities Mr Obama wants to stop without also impeding client-based in-vestment banking he wants them to continue.
Moreover, there is apparently nothing in the proposal to stop former investment banks such as Goldman Sachs and Morgan Stanley simply giving up their newly acquired banking charters and reverting to being non-banks.
In reforms that could force the restructuring of some of the biggest names in US finance, including JPMorgan Chase and Goldman Sachs, Mr Obama promised that “never again will the American taxpayer be held hostage by a bank that is too big to fail”.
Flanked by Paul Volcker, the former Federal Reserve chairman, who has advocated the move for months, Mr Obama called for banks to be banned from running their own trading desks and “owning, investing in or sponsoring” hedge funds and private equity groups.
Tim Geithner, the Treasury secretary, who has come under attack from Democrats on Capitol Hill, backed the plan, officials said, even though his own regulatory proposals have stopped well short of the sweeping Volcker reforms.
Republicans responded coolly, but did not reject the proposals out of hand. Richard Shelby, senior Republican on the Senate banking committee, called for more details and new hearings.
Others accused the White House of adopting a populist message to divert attention away from the blow delivered by the Democrats’ defeat in the Senate race in Massachusetts.
The measures, which require congressional approval, hark back to the response to the 1929 stock market crash that ushered in the Glass-Steagall Act, separating commercial and investment banking, which remained in law until 1999.
Mr Obama called for new rules – beyond current regulations restricting banks from holding no more than 10 per cent of US deposits – that would place unspecified size limits on institutions.
“In recent years, too many financial firms have put taxpayer money at risk by operating hedge funds and private equity funds and making riskier investments to reap a quick reward,” said Mr Obama. “And these firms have taken these risks while benefiting from special financial privileges that are reserved only for banks.”
Congressional aides and administration officials said a lot of detail remained to be decided. Barney Frank, chairman of the House financial services committee, said he would support new rules if they allowed banks to dispose of newly banned operations over three to five years and thereby prevent a “fire sale”.
Bankers said the lack of detail and the likelihood of a protracted debate in Congress would give them the chance both to lobby for changes and to adapt their businesses, with, for example, Goldman possibly giving up the financial holding company status it adopted in the financial crisis.
Tom Hoenig, president of the Kansas City Fed, on Thursday warned against keeping rates too low for too long.
“Experience both in the US and internationally tells us that maintaining large amounts of stimulus over an extended period risks creating conditions that lead to financial excess, economic volatility and even higher unemployment at some point in the future,” he said. Mr Hoenig rejected Mr Bernanke’s argument that the Fed decision to keep rates low after the dotcom crash did not contribute meaningfully to the housing and credit bubble. “Low interest rates contributed to excesses,” he said.
Arguing that economic data are always mixed during the early stages of a recovery, he called on the Fed to “more evenly weigh our short-run concerns against the longer run costs”.
Separately, the Financial Times can reveal that the optimal interest rate in the US has moved above zero, according to a rule of thumb for monetary policy cited by Federal Reserve chairman Ben Bernanke last weekend. The rule of thumb is a version of the so-called Taylor rule, which relates interest rates to unemployment and inflation. It was shown on a chart included in Mr Bernanke’s presentation to the American Economic Association, in which he defended the Fed’s decision to keep rates low after the dotcom bust.
The chart suggested the optimal rate moved above zero around the middle of 2009. On the same basis, the optimal rate is almost certainly above zero today – even though the Fed has kept US rates steady at zero to 0.25 per cent.
The fact that this rule of thumb suggests rates should be above zero highlights the turnround in the situation confronting the Fed since early 2009. At that time, a similar Fed staff analysis suggested the optimal interest rate was minus 5 per cent. The difference reflects the impact of the Fed’s gigantic asset purchase programme and other factors that boosted the outlook for the economy, unemployment and inflation.
The finding is notable because the version cited by Mr Bernanke is forward-looking, uses the Fed’s own forecasts and uses the central bank’s preferred measure of inflation, the personal consumption expenditure deflator. In his speech, Mr Bernanke said such a version was “a more useful benchmark” and “guide to appropriate policy” than the versions of the Taylor rule that used current unemployment and consumer price inflation.
The recommendation of a single rule of thumb does not mean that rate increases are imminent. Fed policy is based on judgment and puts weight on risks as well as the possibility that the neutral interest rate that neither stimulates nor slows the economy can change over time.
The Federal Open Market Committee reiterated in December that it expected to keep rates at “exceptionally low” levels for an “extended period” – commonly interpreted as at least six months. But the rule of thumb suggestion that the optimal rate has risen above zero does underscore the fact that it is no longer unambiguously clear that rates should stay near zero for a very long time.
