See the cheery chappy standing just behind President Obama as he announced his plans for banking reform? That's Paul Volcker, Alan Greenspan's predecessor as Fed chairman. Greenspan was always regarded as too close to Wall Street -- relaxed about dubious lending practices, always in favour of more deregulation and so on. Volcker, less publicity-hungry and arguably (no, actually unarguably) due most of the credit for breaking the inflationary psychology in the US, was never on such good terms with the Street, and it's a pretty good guess that he's off quite a few Christmas card lists as a result of this week's announcements.
A few weeks ago, Volcker bluntly told a business audience that he'd never seen so much as a wisp of proof that financial "innovation" on Wall Street had ever created any real wealth. Obama's proposed reforms are basically intended to ensure that anyone wishing to continue profiting from such innovation (or "self-deluded risk taking" as it might otherwise be called) does so without the safety net of implicit or explicit taxpayer support. Institutions taking deposits from the public, backed by deposit insurance, will in the future have to be kept separate from higher-risk activities such as hedge fund management or proprietary trading. As Mohamed El-Erian of Pimco explained it on CNBC today, banking in the traditional sense of taking deposits and making loans is going to be regulated much more like a utility if Obama and his new pal Paul Volcker get their way.
Bank shares around the world have fallen in response, reflecting fears that other governments may be emboldened to follow suit. In the UK, both the Tories and LibDems are enthusiastic about doing just that, while Gordon Brown is said to be "relaxed" about it all. (Gordon Brown? Relaxed??). The stock markets' reaction is well analysed by Chris Dillow here. In essence (and in case the link doesn't work), Dillow argues that the fall in bank shares proves that traders are nothing without the capital of a large institution to back them up -- which is in itself a sound reason why banks' trading activities should not have even a whiff of government support.
It's arguable (and it's already being argued) that had the Obama-Volcker plan been in place at the time of the recent credit crunch, it wouldn't have made any difference. After all, the proximate cause of the problem was banks like Freddie Mac and Fannie Mae, or Northern Rock in the UK, going overboard with traditional lending activities. But this misses the point. Freddie and Fannie and the Rock were only able to do what they did because of "innovative" transactions put together by the investment banks, led by the now defunct Lehman and Bear. By the time the crisis peaked, mortgages were being thrown around like confetti solely to allow the investment banks to keep generating their massive structuring fees. It wasn't by any means all Lehman's or Goldman's fault, but if the cycle has to be broken somewhere, it certainly makes more sense to curb the investment banks, or at least make them take risks with their own money, than to overregulate the commercial banking sector.
The best piece I've seen on the Obama-Volcker plan so far is this one by Daniel Gross -- worth checking out if only because it must be the first time in human history that Lloyd Blankfein and Malcolm X have been name-checked in the same article. And I'm guessing that there won't be too much sympathy for the banks, judging by this comment shamelessly lifted from The Guardian's website: I've sold my banking stock and moved into tobacco, landmines and animal testing. I see it as an ethical move.
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