As part of his plan to limit the size of banks, President Barack Obama today proposed prohibiting financial institutions that own banks from investing in or advising hedge funds or private-equity funds.
“We intend to close loopholes that allowed big financial firms to trade risky financial products like credit default swaps and other derivatives without oversight,” Mr. Obama said in announcing the plan, which was immediately criticized by financial services industry groups and Republican lawmakers.
The administration proposed the two new reforms, which are in addition to changes put forward in June 2009, to move banks “more to identifying their core business as being something like serving their clients,” an administration official said on a background basis at a telephone press briefing.
Congress is currently working on the regulatory-reform proposals the administration made last year. The House on Dec. 11 approved its version of the financial-reform measures.
The administration’s proposal would substantially crimp the kinds of activities in which banks could engage. Regulators would be required to prevent commercial banks from owning, investing in or advising hedge funds or private-equity funds. Moreover, the president wants to limit the proprietary trading that they do for their own accounts that is not related to the clients’ interests.
The government provides deposit insurance and other safeguards and guarantees to firms that operate banks, the president said in explaining his plan. "But these privileges were not created to bestow banks operating hedge funds or private-equity funds with an unfair advantage," he said. "When banks benefit from the safety net that taxpayers provide, which includes lower-cost capital, it is not appropriate for them to turn around and use that cheap money to trade for profit. And that is especially true when this kind of trading often puts banks in direct conflict with their customers' interests."
Groups representing the financial services industry slammed the administration’s proposal.
The plan is inconsistent with achieving the goals of promoting responsible lending, increasing jobs and promoting a stronger economy, Steve Bartlett, president and chief executive of The Financial Services Roundtable, said in a release. “The proposal will restrict lending, increase risk, decrease stability in the system and limit our ability to help create jobs,” he said.
The Securities Industry and Financial Markets Association also criticized the administration’s plan. In a statement, SIFMA president and chief executive Tim Ryan said the best way to achieve the goals of ending “too big to fail” and protecting against systemic risk “is to [establish] a tough, competent and accountable systemic-risk regulator.” Mr. Ryan added that “providing for strengthened regulatory oversight and flexibility like that originally proposed by the administration, as opposed to arbitrary restrictions on growth and activities, is a more effective way of mitigating systemic risk ending ‘too big to fail.’”
Senate Banking Committee Chairman Christopher Dodd, D-Conn., issued a statement supporting the changes. “The financial crisis highlighted the dangers of excessive risk taking by financial institutions,” he said. “I agree with President Obama that taxpayers should not be underwriting these risky activities.”
But Rep. Spencer Bachus, R-Ala., the ranking member of the House Financial Services Committee, said in a statement that the problems being targeted by the president would be better addressed by legislation proposed by Republicans. “The Republican plan would end the bailouts, get the government out of picking winners and losers, and restore market discipline,” he said.
Financial firms could continue to make markets, since that would be a service for customers, said one administration official speaking at the background press briefing.
The official denied that the changes would constitute returning to regulations in effect for many years under the Depression-era Glass-Steagall Act, which was repealed in 1999. “We’re not returning to Glass-Steagall,” the official said. “This is about making sure that firms that own banks aren’t doing trading for their own account, not for the benefit of their customer, and benefiting from taxpayer subsidies due to deposit insurance and the discount-window access.”