White House economics adviser Paul Volcker urged lawmakers to restrict risks taken by large banks and adopt regulations that would prevent them from becoming "too big to fail."The former Federal Reserve Chairman defended President Obama's proposals to bar commercial banks from owning risky investment vehicles or engaging in speculative trading on their own accounts in testimony before the Senate Banking Committee Tuesday. Volcker told the committee the president's plan was "particularly designed to help deal with the problem of 'too big to fail' and the the moral hazard that looms so large following the emergency bailouts of financial institutions.
"Hedge funds, private equity funds, and trading activities unrelated to customer needs . . . should stand on their own, without the subsidies implied by public support for depository institutions," Volcker said.The president first proposed the new Wall Street regulations, known as the Volcker Rule, in late January following the Democratic defeat in the Massachusetts Senate race.
The Volcker Rule would prevent commercial banks such as Bank of America (BAC) and JPMorgan Chase (JPM) from owning hedge funds and private equity funds, as well as bar them from speculative or proprietary trading. Banks have countered that it's impossible to unwind proprietary trading from critical market making operations, and that's it's impossible to define so-called prop trading, anyway.
Volcker dismissed such arguments out of hand. "Every banker I speak with knows very well what 'proprietary trading' means and implies," Volcker told the committee. "My understanding is that only a handful of large commercial banks -- maybe four or five in the United States and perhaps a couple of dozen worldwide -- are now engaged in this activity in volume."
The former fed chief, who served from 1979 to 1987, also railed on the "strong conflicts of interest" created when commercial banks engage in proprietary of private investment activity.
"I want to note the strong conflicts of interest inherent in the participation of commercial banking organizations in proprietary or private investment activity," Volcker said. "When the bank itself is a 'customer,' i.e., it is trading for its own account, it will almost inevitably find itself, consciously or inadvertently, acting at cross purposes to the interests of an unrelated commercial customer of a bank."
Volcker added that he is not so naive as to think that all potential conflicts could be expunged from banking, "but neither am I so naive as to think that, even with the best efforts of boards and management, so-called Chinese Walls can remain impermeable against the pressures to seek maximum profit and personal remuneration."
Volcker Urges Lawmakers to End Era of 'Too Big to Fail'