The United States government should not stand behind banks that mix their trading with their banking activities, former Fed Chairman Paul Volcker told CNBC Monday.
“If you don’t have this rule [known as the Volcker rule or Volcker plan], what stops any financial institution from buying a bank, saying I’m a bank and getting a banking license, mixing up their trading activities with their banking activities,” said Volcker, as he discussed financial reform, now being debated in Congress, including derivatives. Volcker is chairman of the Economic Recovery Advisory Board, under Obama.
“We do not want the United States government implicitly standing behind the trading activities of these institutions.”
Volcker said the practice of combining trading with banking in one institution affects few banks—about five—but that those five are very large institutions.
"It's very hard to make a distinction between a bank and holding company and its affiliates," he added. "They are all under common management: They are all, at the end of the day, mutually supportive."
The Volcker rule is Paul Volcker’s idea to restrict banks from making certain types of speculative investments, such as trading deriviatives, if those investments aren’t in their customers’ interests. Volcker has argued that such speculative activity played a key role in the financial crisis.
Volcker said it’s important that adequate capital support derivatives, which has been a problem in the past. “There certainly should be capital behind it, whether it’s in the bank or separately in the holding company,” added Volcker.
William Isaac, former head of the FDICand the author of Senseless Panic: How Washington Failed America, told CNBC Monday, as he was being jointly interviewed with Volcker, that he doesn't believe that an effective firewall can be placed between a bank and its affiliate to prevent it from failing.
“Either you’re going to protect the whole organization or you’re not,” said Isaac. “You can’t let an affiliate fail, if your objective is to protect the entire organization.
“Can you imagine the largest banks in the country seeing its affiliates go down and not have it cause a run on the bank and a total loss of confidence in the bank?”
Isaac added that regulation is good for banks in that they can profit from their activities, not just be subject to the risks.
For more of the Volcker and Issac interview, watch the Kudlow Report at 7pm ET.