If losing a senate seat in Massachusetts is what it took to make this administration finally address the excesses that led to the largest financial collapse in eighty years, then the American people owe the voters of Massachusetts a big thank you.
The president has finally embraced many elements of financial reform that will make banking a lot more boring but a lot more stable for years to come. At the heart of his announcement today is a proposal to prevent bank holding companies from engaging in proprietary trading for their own profit. These firms with access to the Fed’s discount window – and therefore an implicit taxpayer funded backstop – would no longer be able to gamble with other people’s money in order to make a profit. In essence, it is an attempt to reestablish separation between investment banks and commercial banks, which over the past several decades have engaged in taxpayer-guaranteed arbitrage that finally resulted in the financial meltdown of 2008.
In large measure, banks like Goldman Sachs have acted more as a hedge fund than as the bank holding companies they purport to be. Goldman has admitted to trading against some of the same bets it has urged its clients to take. The fact that it and other bank holding companies can engage in risky behavior with money borrowed from the Fed is egregious.
These banks have every right to earn record profits and to reward their employees as they see fit – provided that taxpayers are not on the hook for the outsized gambles they take with our money. As long as there is an implicit taxpayer guarantee for both the bank holding companies and the counterparties with which they do business, proprietary trading for profit should be banned.
Opponents will argue that this curb on American banks will only strengthen foreign banks and spell the end of Wall Street’s global reach. Nonsense. It was only a decade ago that Congress foolishly passed the Gramm-Leach-Bliley Act, which effectively repealed Glass-Steagall. Before 1999, the United States led the way as the world’s financial nerve center. If Obama’s proposals are enacted into law, our banking system will still be the envy of the world, as it had been for generations before Glass-Steagall was repealed.
An outstanding issue is whether former investment banks that applied for a commercial bank charter in order to get access to the Fed’s discount window can simply revert back to their former status now that the crisis has passed. The big banks will certainly not give up on profitable proprietary trading without a fight and there have already been some suggestions that they simply convert back to the investment banks many of them were before the financial meltdown.
This, of course, won’t entirely solve the underlying problem that was a major component of the financial collapse. As long as there is the understanding that banks which are too big to fail – and which have grown even bigger as they have gobbled up their less successful competitors over the past several years – will be bailed out by the taxpayers, there is no reason for investment banks to stop gambling. But today’s announcement is a long-overdue step in the right direction. If Wall Street wants government out of its business, it needs to stop relying on the government’s money as a hedge against excessive risk taking.
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Julie Roginsky is a CNBC contributor who has extensive experience in government, politics and public relations on both the federal and state levels including serving as the Washington communications director for former Senator Jon Corzine.