Banking reform seems likely, not moment too soon

David Pauly

05/01/2010

If there ever were a moment for reining in America’s cowboy banks, this is it.
Folks across the nation are fed up with banker bailouts and bonuses – and American lawmakers finally are listening more to them than to Wall Street’s lobbyists. The proposed Volcker rule for restricting bankers’ securities trading, once dismissed by pundits as a pipe dream, is very much in play.
The Securities and Exchange Commission’s fraud suit against Goldman Sachs Group Inc. is the clincher for reform. Goldman Sachs loses even if it wins the legal case or settles out of court. Will anybody trust investment bankers who think betting against their own clients is ethical?
Bank reform also gives Congress a chance to restore a bit of its reputation, now at a low. Christopher Dodd and Richard Shelby, the top Democrat and Republican, respectively, on the Senate Banking Committee, have said they are close to approving a bill on bank regulation. The House already has passed its measure.
Banks would get smaller and perhaps less likely to fail if the Volcker rule, named after former Federal Reserve Chairman Paul Volcker, passes. The proposal would forbid banks to trade securities for their own account – which can create conflicts with customers – or to invest in hedge funds or buyout funds.
Wall Street will resist giving up proprietary trading, because it has been so profitable. The banks would probably spin off this activity from the rest of their business, perhaps putting it into an old-style partnership, thus transferring all the risk back to the partners, not public shareholders and taxpayers. Banks might go even farther, splitting off all trading or even all investment banking from commercial banking. More, smaller companies may be beneficial for the industry. Outfits such as Citigroup Inc. and Bank of America Corp., which thought size and wide product diversity were the keys to profit, were on the brink of bankruptcy before the government rescued them.
Congress seems to be reaching a consensus that all or most derivatives trading should be done on exchanges. This would mean that trades in such instruments as the credit default swaps that overwhelmed American International Group Inc. would be done by well-capitalized firms and with the assurance they would be completed.
You know this is a good idea because Wall Street chiefs insist that many derivative contracts are too customized to be fit for exchange trading. Believe that if you want to. The broader view is that banks find it more profitable to trade in the dark where they dictate the prices rather than on a well-lit exchange where all buyers and sellers set prices.
What bank bosses don’t get is that properly regulated banks will thrive.
The high-risk trading that fomented the recent credit crisis and recession was not an aberration. Banks as now constituted reward risky behavior. When government overseers insist they hold adequate capital and pay their people rationally, bankers and their shareholders will be better off.
Let’s not mess it up. &#8226

David Pauly is a Bloomberg News columnist.

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