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The fallout from the "Volcker Rule," President Barack Obama's proposal to ban banks from making speculative investments that do not benefit their customers, rattled stock and bond markets last week as analysts panicked over the possible repercussions.
At its heart, the plan would fundamentally change the banking industry, separating commercial banks from investment banks, a line that was muddled over a decade ago by the repeal of the Glass-Steagall Act.
"Never again will the American taxpayer be held hostage by a bank that is too big to fail," Obama said Thursday.
Obama announced the plan with former U.S. Federal Reserve Chairman Paul Volcker at his side. Volcker has been stumping for months for increased regulatory control, and the President credited him for the plan's design, dubbing it the "Volcker Rule."
At its heart, the plan would fundamentally change the banking industry, separating commercial banks from investment banks, a line that was muddled over a decade ago by the repeal of the Glass-Steagall Act.
"Never again will the American taxpayer be held hostage by a bank that is too big to fail," Obama said Thursday.
Obama announced the plan with former U.S. Federal Reserve Chairman Paul Volcker at his side. Volcker has been stumping for months for increased regulatory control, and the President credited him for the plan's design, dubbing it the "Volcker Rule."
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In addition to curtailing private-equity and hedge fund investments, the plan bars banks from running proprietary trading operations solely for their own profit. Obama has argued that such speculative activity played a key role in the financial crisis.
The administration also wants to limit the ability of the largest banks to use borrowed money to fund expansion plans, calling for expansion of a 1994 law that forbids banks from acquiring another bank if the deal would give it more than 10% of the nation's insured deposits.
When asked to assess the effect of the proposal, many analysts were concerned that the economic recovery put in jeopardy and the rebound in Standard & Poor's 500 Index earnings from a record nine-quarter slump will be curtailed.
"Authorities are certainly treading a fine line between curbing bubbles and choking off economic growth," Jim Reid, the London-based head of fundamental strategy at Deutsche Bank AG (NYSE: DB), wrote in note to investors obtained by Bloomberg News.
The bond market was also unsettled as investors demanded higher yields for corporate bonds. The spread between Treasuries and corporate bonds widened to 272 basis points from the low this year of 266 basis points, or 2.66 percentage points, on Jan. 14, according to the Bank of America Corp.'s (NYSE: BAC) Merrill Lynch U.S. Corporate & High Yield Master Index.
Analysts worried that Obama's plan could permanently raise borrowing costs for U.S. businesses if banks respond to the rules by returning to tighter credit guidelines.
"All these regulatory actions could cause unintended consequences, including a greater perception of risk related to government intervention in the financial sector," Pri De Silva, a bank and brokerage analyst at debt research firm CreditSights Inc. in New York told Bloomberg.
That would change Wall Street's role in private equity funding, where financial institutions invest money to buy companies, real estate and other assets. U.S. banks account for 9% of private-equity capital, having raised more than $80 billion for their private-equity funds since 2006, and investing $94 billion with other managers, according to Preqin Ltd., a London-based research firm cited by Bloomberg.
While financial institutions could still manage assets on behalf of clients, they wouldn't be able to invest in their own funds or those run by firms such as Blackstone Group LP (NYSE: BX) and KKR & Co.
The plan could force JP Morgan & Co. (NYSE: JPM) and Goldman Sachs Group Inc. (NYSE: GS) to shed their private equity businesses. JPMorgan might have to sell its One Equity Partners private-equity business, which invests the firm's money. Goldman would have to jettison its private-equity business, which will be difficult because the unit invests its own money in the same funds that clients invest in.
But critics say targeting private-equity investments doesn't go to the root of the problems of the financial crisis and will only dry up funding.
"In a world where there is less capital available for private equity and hedge funds, this will take out another source of funding," Bruce Ettelson, head of the fund- formation group at law firm Kirkland & Ellis LLP in Chicago told Bloomberg.
"You can choose to engage in proprietary trading, or you can own a bank, but you can't do both," an administration official told The Wall Street Journal.
An analysis of five banks obtained by Bloomberg said Obama's proposals would hurt Goldman Sachs the most, resulting in an estimated $4.67 billion drop in sales in 2011. It would cost Goldman Sachs, Morgan Stanley (NYSE: MS), Credit Suisse Group AG (NYSE: CS), UBS AG (NYSE: UBS) and Deutsche Bank a total of about $13 billion in revenue next year, according to JPMorgan analysts.
In fall 2008, as the credit crisis was getting underway in earnest, investment banks Goldman Sachs and Morgan Stanley formally became banks - letting them access Fed bailouts and guarantees of their loan activity in financial markets.
As outlined by an in-depth Money Morning investigative series just as the financial crisis was peaking, the banks were able to borrow at low rates from the government's $250 billion "recapitalization" effort.
But instead of lending the money and pumping liquidity into locked up credit markets, the banks used billions of government money to buy out smaller rivals and turn profits trading for their own accounts by speculating in the market.
At the time, some of the banks even outright refused to discuss the matter.
"We have not disclosed that to the public. We're declining to," Thomas Kelly, a spokesman for JP Morgan told The Associated Press.
It's hardly a surprise that the government took notice of these shenanigans and is now seeking to rein back the banks activities.
"We started coming out of the rescue and you saw some of the biggest financial institutions . . . who had access to cheap financing . . . use that money without lending or anything, just doing their own investments," Austan Goolsbee, a member of the president's Council of Economic Advisers told the Washington Post. "That clearly started putting [the issue] on the radar screen for us."
The bank's moves gave Mr. Volcker and his allies new fuel for their argument that government-backed banks should be prohibited from taking big trading risks.
Thursday's announcement is just the latest move by the White House to target Wall Street and banks.
The House already has passed a provision that would give regulators new authority to limit the size and scale of banks. Earlier this month, the president proposed a new fee on large banks and insurance companies that would raise $90 billion over 10 years to offset the costs of the bailout of financial firms and auto giants.
The fate of the Obama proposal is uncertain. But in a political environment clearly hostile to big banks, Democrats might need only a few Republican votes to enact the new rules.
News & Related Story Links:
The administration also wants to limit the ability of the largest banks to use borrowed money to fund expansion plans, calling for expansion of a 1994 law that forbids banks from acquiring another bank if the deal would give it more than 10% of the nation's insured deposits.
When asked to assess the effect of the proposal, many analysts were concerned that the economic recovery put in jeopardy and the rebound in Standard & Poor's 500 Index earnings from a record nine-quarter slump will be curtailed.
"Authorities are certainly treading a fine line between curbing bubbles and choking off economic growth," Jim Reid, the London-based head of fundamental strategy at Deutsche Bank AG (NYSE: DB), wrote in note to investors obtained by Bloomberg News.
"Unintended Consequences"
Around the world, stocks and commodities took a hit on Thursday and Friday. The Dow Jones Industrial Average gave back much of last year's gains and commodities dropped to new 2010 lows. Both crude oil and gold futures slipped in New York trading, retreating for three days in a row.The bond market was also unsettled as investors demanded higher yields for corporate bonds. The spread between Treasuries and corporate bonds widened to 272 basis points from the low this year of 266 basis points, or 2.66 percentage points, on Jan. 14, according to the Bank of America Corp.'s (NYSE: BAC) Merrill Lynch U.S. Corporate & High Yield Master Index.
Analysts worried that Obama's plan could permanently raise borrowing costs for U.S. businesses if banks respond to the rules by returning to tighter credit guidelines.
"All these regulatory actions could cause unintended consequences, including a greater perception of risk related to government intervention in the financial sector," Pri De Silva, a bank and brokerage analyst at debt research firm CreditSights Inc. in New York told Bloomberg.
Private Equity & Hedge Funds Are Losers
One of the key provisions in the new rules would prohibit banks that accept federally insured deposits or borrow from the Federal Reserve, from owning, investing in, or sponsoring hedge funds or private-equity firms.That would change Wall Street's role in private equity funding, where financial institutions invest money to buy companies, real estate and other assets. U.S. banks account for 9% of private-equity capital, having raised more than $80 billion for their private-equity funds since 2006, and investing $94 billion with other managers, according to Preqin Ltd., a London-based research firm cited by Bloomberg.
While financial institutions could still manage assets on behalf of clients, they wouldn't be able to invest in their own funds or those run by firms such as Blackstone Group LP (NYSE: BX) and KKR & Co.
The plan could force JP Morgan & Co. (NYSE: JPM) and Goldman Sachs Group Inc. (NYSE: GS) to shed their private equity businesses. JPMorgan might have to sell its One Equity Partners private-equity business, which invests the firm's money. Goldman would have to jettison its private-equity business, which will be difficult because the unit invests its own money in the same funds that clients invest in.
But critics say targeting private-equity investments doesn't go to the root of the problems of the financial crisis and will only dry up funding.
"In a world where there is less capital available for private equity and hedge funds, this will take out another source of funding," Bruce Ettelson, head of the fund- formation group at law firm Kirkland & Ellis LLP in Chicago told Bloomberg.
Trading Operations Derailed
In addition to curtailing private-equity and hedge fund investments, the plan bars banks from running proprietary trading operations solely for their own profit."You can choose to engage in proprietary trading, or you can own a bank, but you can't do both," an administration official told The Wall Street Journal.
An analysis of five banks obtained by Bloomberg said Obama's proposals would hurt Goldman Sachs the most, resulting in an estimated $4.67 billion drop in sales in 2011. It would cost Goldman Sachs, Morgan Stanley (NYSE: MS), Credit Suisse Group AG (NYSE: CS), UBS AG (NYSE: UBS) and Deutsche Bank a total of about $13 billion in revenue next year, according to JPMorgan analysts.
Banks Misused Funds
While many bankers and financial industry analysts were startled and disheartened by Obama's proposal, the argument can be made that the new regulatory storm can be blamed on the banks themselves.In fall 2008, as the credit crisis was getting underway in earnest, investment banks Goldman Sachs and Morgan Stanley formally became banks - letting them access Fed bailouts and guarantees of their loan activity in financial markets.
As outlined by an in-depth Money Morning investigative series just as the financial crisis was peaking, the banks were able to borrow at low rates from the government's $250 billion "recapitalization" effort.
But instead of lending the money and pumping liquidity into locked up credit markets, the banks used billions of government money to buy out smaller rivals and turn profits trading for their own accounts by speculating in the market.
At the time, some of the banks even outright refused to discuss the matter.
"We have not disclosed that to the public. We're declining to," Thomas Kelly, a spokesman for JP Morgan told The Associated Press.
It's hardly a surprise that the government took notice of these shenanigans and is now seeking to rein back the banks activities.
"We started coming out of the rescue and you saw some of the biggest financial institutions . . . who had access to cheap financing . . . use that money without lending or anything, just doing their own investments," Austan Goolsbee, a member of the president's Council of Economic Advisers told the Washington Post. "That clearly started putting [the issue] on the radar screen for us."
The bank's moves gave Mr. Volcker and his allies new fuel for their argument that government-backed banks should be prohibited from taking big trading risks.
Thursday's announcement is just the latest move by the White House to target Wall Street and banks.
The House already has passed a provision that would give regulators new authority to limit the size and scale of banks. Earlier this month, the president proposed a new fee on large banks and insurance companies that would raise $90 billion over 10 years to offset the costs of the bailout of financial firms and auto giants.
The fate of the Obama proposal is uncertain. But in a political environment clearly hostile to big banks, Democrats might need only a few Republican votes to enact the new rules.
News & Related Story Links:
- Money Morning:
Goldman's Earnings Call Overshadowed by Obama's Glass-Steagall Revival - Bloomberg:
Stocks, Commodities Fall on Obama, China; Emerging Markets Drop - Bloomberg:
Corporate Spreads Widen, Morgan Stanley Pays Up: Credit Markets
- Wall Street Journal:
New Bank Rules Sink Stocks
- Washington Post:
Obama bank plan shifts power from Geithner
- Money Morning:
Billions in U.S. Bank Rescue Funds are Fueling Buyouts Worldwide – Instead of Lending at Home
- Money Morning:
Billions in Bank Rescue Funds are Fueling Buyout Deals, and not the Increase in Loans That Would Help Ease the Financial Crisis - Money Morning:
U.S. Banks Refuse to Detail How They're Spending Federal Bailout Money
Tags: Barack Obama, Hedge Funds, Paul Volcker, Stocks, Wall Street
I concur with the the "Volker Rue".
Main Street was paying to save Wall Street.
Now Main Street will be paying once more for the crusade against Wall Street.
Markus,
Were you in London at JPMorgan during the 90's? If so, Chris and I would love to be in touch…
The banking industry is not alone when it comes to the need of enforcing anti-trust laws.
What does the American auto industry, the health care industry, wall street firms and the banking industry all have in common; other than they were all on the brink of failure?
These are industries where the production side of the industry is no longer a free market with many producers competing head-to head to earn the business of consumers, or customers, of the industry. Instead each of these industries are controlled by a relatively small number of very large corporations that have transformed these markets into oligopolies.
Adam Smith when he discussed “rational self interest” and competitive markets in his book Wealth of Nations, envisioned many consumers buying goods and services from many producers with everyone looking out for their self-interest. By keeping markets “free”, producers pursue their rational self-interest and this best meets the needs of the consumers and the citizens of our country, who are also looking out for their self-interest. Under this system, what is in the producers self interest is to provide the best product possible to the consumer, while striving to be a low cost producer for their niche.
This consolidation of markets began in the late 1960's early 1970's in the auto industry when it was transformed from a free market to an industry that was controlled by three giant corporations and one union. As this transformation was occurring the auto company's and auto union's self-interest became separated from what the consumer wanted and/or needed. Competition between the companies broke down and this gave an opening for foreign competition to enter our markets and the beginning of the end of the American auto industry as we knew it.
Other industries saw what was happening in the auto industry and saw that government was not objecting so naturally they followed the same path with little concern on any ones part that we were losing our free market system to a more centralized market system of oligopolies. As a result we now have major markets where the producing entities self-interest is not always in line with the self-interest of the consumer. What is in the self-interest of the entities in these industries is to keep the oligopoly alive. Thus the creation of special interests and lobbyists.
These oligopolies have bought the protection of our representatives in Washington and state capitals. I am always baffled by the fact that corporations and unions cannot vote in this country, however they are allowed to buy votes with their contributions.
We lost track of a key ingredient that Adam Smith identified as necessary in order for “rational self interest” to work. There must be many producers. In too many industries, the number of producers has shrunk and the ones remaining have gotten “too big to fail”. This is true in the auto industry, the banking industry, wall street, health care and will soon be true in the computer software industry.
When discussing the health insurance industry proponents for this specific oligopoly site the fact that the bigger the insured pool, the lower insurance premiums can be. However, I submit that this "bigger pool savings" is more than offset by the fact that the rational self-interest of the companies is not totally aligned with the rational self interest of the insured. The insurance industries self-interest is to keep the oligopoly alive. The self-interest of the insured is to have as many insurance companies as possible clawing to get his business and thus ringing out all excessive cost, including unconscionable salaries for top executives, to earn the consumers business.
The liberals are right that regulation is required and conservatives are right that a free market is the best way to meet the needs and wants of our citizens. The common ground is that regulation is essential to make our markets more free. We have too many industries where companies have too much power, their self interest is not aligned with the citizens of this country and they are too big to fail.
It is time that our politicians breakaway from the shackles of oligopolies, special interests groups and lobbyists. Use antitrust legislation to bring back free markets.
Why doesn't Obama trust Banks to distribute capital in the economy. They can do a better job than any government official can do. Consumers have borrowed too much already, why the push to have them borrow more? As to the new rules on proprietary trading, all I hear is don't invest in risky assets, invest in government bonds… a la Argentina!
penney stock newsletters have left messages on the site where I check my stock. They say there is a rumer about acas or acas is going to be huge. I have a lot of it, bought it @$34.00. never sold it. Can you tell me what to do about acas??? I have asked 2 others but they will not reply. They put it there,why not reply. So I have not signed up with a newsletter service yet
President Obama has come to right decisions after lapse of valuable time. Both the banks/financial institutions and insurance companies have not used shareholders' and tax payers' money in right manner. Better late than never. But do it pronto Mr. President. The world is counting on your firm decisions and immediate action. Best wishes.
While the banks haven't exactly been customer friendly during the last 2 years, one can only wonder if this is not just some sort of payback attack aimed at the very same banks the government has bailed out. Is this really going to help our economy, or is it because they invested for their own benefit, that the government is upset about.
Main Street was paying to save Wall Street.
Now Main Street will be paying once more for the crusade against Wall Street.
Wonder who made Main Street save Wall Street? Further wonder who is making Main Street to pay once more?
Throw the bums out.