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U.S. President Barack Obama speaks about financial reform after his meeting with Presidential Economic Recovery Advisory Board chair Paul Volcker, left, at the White House in Washington. (KEVIN LAMARQUE)
U.S. President Barack Obama speaks about financial reform after his meeting with Presidential Economic Recovery Advisory Board chair Paul Volcker, left, at the White House in Washington. (KEVIN LAMARQUE)

Obama picks populist fight by taking on the big banks Add to ...

kyakabuski@globeandmail.com

A newly assertive Barack Obama, smarting from his party's stunning loss of a normally secure Senate seat, has concluded that one way back into doubting Americans' hearts is through their hate-on for Wall Street.

After repeatedly rejecting calls to put the vise to the banking industry, which has roared back to profitability only months after being bailed out by U.S. taxpayers, the President yesterday signalled he will prohibit financial institutions from growing too large or engaging in risky trading practices with depositors' money.

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If enacted by Congress, the measures would constitute the most significant re-enforcing of U.S. bank regulation since the Great Depression and would arrest the steady relaxation of financial rules that has occurred since the 1980s.

Mr. Obama is proposing a cap on bank size that would go far beyond current rules limiting a single institution to 10 per cent of overall deposits. His plan would also make it illegal for most deposit-taking institutions to trade on their own behalf, a measure aimed at reducing banks' exposure to the kinds of risky products that almost brought down the financial system in 2008.

The President, who has until now preferred consensus over confrontation, vowed to drop the gloves should bankers unleash lobbyists on Capitol Hill to quash the proposals: "If these folks want a fight, it's a fight I'm ready to have." Republicans intend to take him up on that. The President's tough talk was immediately ridiculed as "faux-populism" by New Jersey GOP Congressman Scott Garrett.

The President did not offer specific remedies for the main source of public ire toward the banks - the executive bonuses that Mr. Obama yesterday labelled as "obscene." And the rules unveiled by the President raised as many questions as they answered. The White House provided almost no details on how they would be applied, though analysts were quick to parse the President's language to determine whether the overhaul is as far-reaching as he seemed to indicate.

But the proposals stunned Wall Street, and rocked stock markets, in part because the Obama administration had previously appeared to rule out using such blunt instruments to discipline the banks. The Dow fell 213 points yesterday and the TSX tumbled 210 points. What's more, the move signals an apparent comeback for Paul Volcker, the former chairman of the U.S. central bank who heads the President's economic recovery advisory board, but whose calls for stricter regulation had been dismissed by top White House operatives.

That, however, was before the Democratic candidate in Tuesday's race to fill the late Ted Kennedy's Massachusetts Senate seat succumbed to a wave of populist anger at the Obama administration, handing Republicans a game-changing victory. A chastened Mr. Obama conceded the following day that voters were reacting in part to his perceived "remoteness" and "detachment."

Now, the President wants to prove he's on the side of the little guy by taking aim at a banking industry that is "still operating under the same rules that led to its near collapse." "The forces within the White House shifted dramatically about 8 o'clock on Tuesday night," James Cox, a professor of corporate and securities law at Duke University in Durham, N.C., opined in an interview. He was referring to Mr. Volcker's apparent rehabilitation after having been sidelined for months by Treasury Secretary Timothy Geithner and Lawrence Summers, Mr. Obama's top economic adviser.

On the surface, the new rules would appear to usher in a sober new era on Wall Street, where commercial banks had strayed beyond their core businesses in recent years to engage in speculative investing.

If Congress enacts the limits proposed by Mr. Obama, federally regulated banks and their subsidiaries could no longer engage in that kind of risk-taking. Such activities are seen to have contributed to the financial meltdown because banks, had an incentive to take big risks knowing they were insulated from debilitating losses by taxpayer backstops.

Still, the proposals do not appear to prohibit banks from trading in the same kind of risky financial products on behalf of clients. As a result, Mr. Obama's move yesterday "is the kind of thing the public, in its anger at the moment, will buy without really understanding what it means," offered Lawrence Baxter, who also a professor at the Duke law school. "But it may not have the effect they're looking for, which is greater safety and soundness in the financial system, because it was the underlying financial products, not the trading practices, that were the problem."

For years, those trading activities were wildly profitable. But taxpayers had to bail them out when hundreds of billions of dollars worth of bets on risky financial instruments went bad in 2007 and 2008.

Only months later, banks have resumed their previous behaviour - and profitability. Goldman Sachs, for instance, yesterday reported a record annual profit of $13.4-billion (U.S.) in 2009, much of it from "proprietary trading." What's more, the firm set aside an eye-popping $16.2-billion for salaries and executive bonuses.

The President will require the co-operation of Democrats in Congress to enact his proposals. While members of the House of Representatives are generally more amenable to cracking down on the banks, Mr. Obama could have a tougher row to hoe in the Senate.

The head of the Senate banking committee, Connecticut Senator Chris Dodd, last week reportedly rejected the idea of creating a new regulatory body with an explicit mandate to protect consumers from mistreatment by banks.

The House bill contains such a measure, however, and, after the loss of the Kennedy fortress in Massachusetts, some Senate Democrats facing re-election this fall may be inclined to seek salvation in anti-bank populism. Just like Mr. Obama.

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INSIDE OBAMA'S PLAN

THE GOAL

Reduce the risk of another economy-crushing financial crisis, stop the banks from using depositors' money for risky trading activities and rebuild the fortunes of the President and his party by tapping into public anger over the banks' renewed hefty trading profits and fat employment bonuses.

THE GUIDING LIGHT

The new plan bears the thumbprints of revered former Federal Reserve chairman Paul Volcker. His views had been given short shrift by Obama advisers until the big Wall Street banks began throwing their weight around again.

THE GOODS

Bank-bashing is always a smart political move. But the fact is, the proposed regulations would not have prevented a housing bubble fuelled by cheap credit. At the end of the day, bad lending practices cannot be legislated away, and financial institutions typically repeat their mistakes about once a decade.

The presidential ambition

U.S. President Barack Obama proposes reining in the potential size, complexity and risk-taking capacity of the big U.S. banks through what amounts to an updated version of the 1933 Glass-Steagall legislation, which separated commercial and investment banking from the depths of the Great Depression until the 1990s.

What it would mean

The proposed regulations would bar commercial banks from: trading in securities for their own profit; operating, sponsoring or investing in hedge funds or private equity vehicles; and trading complex financial derivatives such as credit default swaps without oversight. They would still be able to trade securities on behalf of clients. A cap on the market share of deposits and other liabilities held by any single bank would also be enforced.

Who would be affected

The regulations are aimed at the surviving banking heavyweights, including JPMorgan Chase & Co., Citigroup, Bank of America, Goldman Sachs and Morgan Stanley. The latter two became commercial banking companies at the height of the crisis to obtain access to cheap loans from the Federal Reserve and would be affected only if they retained that status and took consumer deposits. The targeted banks are chief among the culprits blamed by the government for the financial collapse through their aggressive pursuit of short-term profits at the expense of the long-term health of the financial system.

effect on foreign banks

If they operate commercial banks in the United States, they would face the same curbs on speculative trading and size.

Will it happen?

The plan requires congressional approval, a key stumbling block to other efforts at financial, fiscal and health-care reforms. But this is a midterm election year, and opponents of sweeping regulatory changes can hardly be seen siding with bankers in the midst of an economic slump. Nevertheless, parts of the proposal are sure to be watered down. And the banks, which fear that less-regulated global competitors will steal market share, will mount a strong counteroffensive. They have already argued that the proposal will boost risk and limit lending.

BRIAN MILNER

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