Friday, January 22, 2010

First Thoughts on Obama's Bank Reform Plan and the Comeback of a Legend

A more cynical view would be tempted to argue that the aggressive roll-out of the Administration's bank reform proposal yesterday was meant to quickly divert the public's attention from the Massachusetts election and ensuing unraveling of the health care reform plan. However true this may actually be, it should not detract from the merits of the proposed legislation that is widely, and accurately, reported to be the brainchild of Paul Volcker's efforts to address the fundamental causes that led to the recent financial crisis.

The three key elements of the proposed plan (1. limiting the size of banks, 2. prohibiting proprietary trading activities, and 3. prohibiting banks from investing in private equity firms or and hedge funds) are all appropriately far-reaching measures that go tot he heart of the reasons that caused the near- meltdown of the financial system in the last 18 months.

In the midst of the initial sense of gratification that one would feel to see that serious, drastic measures to address the root cause of what was wrong with the banking industry are now being put on the table, it is also imperative to view everything in a more realistic context and not uncork the proverbial champagne yet.

To begin with, as the messy process involving the proposed health care legislation demonstrated all too well recently, a proposal is not tantamount to actual legislation. In fact, despite the populist undertones that a plan to tightly regulate the financial industry inevitably contains, it is far from certain that there will be adequate bipartisan support in Congress to implement such aggressive measures that would take on the powerful industry's critical interests in a major way. In other words, the banking industry does not spend over $1 billion a year on lobbying expenses (an amount likely to skyrocket now) for nothing.

But the other major aspect of the proposed plan that may undercut its significance is the extent to which other countries would be willing to go along with comparable measures. Early response in Europe has been overall positive (that is, outside the stock markets), with warm endorsement of the plan by the major political parties in the U.K. (where it is also fully consistent with the views of the Bank of England Governor, Mervyn King) and generally supportive, but somewhat more guarded, comments coming from officials in continental Europe.

The degree of support that Obama's proposals will receive from other governments with developed financial market structures will be key to the ability of those measures to achieve their intended objective, even of they were to be converted into law fully in this country. In a global financial market universe, prohibiting banks from engaging in certain types of risk activities in some countries only would quickly lead to the emergence of other "locales" as the new financial centers for such activity that would escape those restrictions; the net result of that would be to re-inject systemic risk into the picture that could destabilize the global financial system again.

On an entirely separate aspect of yesterday's unveiling of the proposal, the unqualified deference that Obama showed toward Paul Volcker by referring to the plan as "the Volcker rule" and the sheer fact that the legendary former Fed Chairman was standing right next to the President of the United States brought some unmistakable echoes from the past. Thirty years after Volcker shook the world by launching his monumental, and utterly successful, fight to drive inflation out of the system, there he was again, at the twilight of his career and life, deservedly basking in the spotlight, offering again his trademark, courageous, no-nonsence, solutions to the biggest financial crisis since the Great Depression.

For someone like myself, who has always admired the man's extraordinary integrity, competence, and selfless committment to public service, it was gratifying to see Paul Volcker on center stage again. He still stands as tall as ever.

Anthony Karydakis

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