Fisher Investments Editorial Staff
Politics, Monetary Policy

A Limiting Proposal

By, 01/22/2010

Story Highlights:

  • President Obama proposed to "limit" the size of banks and "prevent excessive risk taking" Thursday. But few details were forthcoming.
  • The limits (if clarified, then passed) could look a lot like the Glass-Steagall Act of 1933, which separated commercial and investment banking and was overturned in 1999 by the Gramm-Leach-Bliley Act.
  • Reform talk (and possibly action) shouldn't surprise and will likely contain some good points, some bad. We won't know how all that shakes out until we see some actual bills emerge from Congress.


Stocks took quite a beating Thursday—their worst day in months. Not coincidentally, on Thursday, President Obama also announced a new Financial regulatory overhaul plan—his stated aim was to "limit" the size of banks and "prevent excessive risk taking". But his announcement lacked details, and likely more than anything, stocks reacted sharply to the uncertainty, not any regulatory specifics.

The proposed legislation (dubbed the Volcker Rule) targets large financial institutions—those deemed "too big to fail" (Bank of America, JP Morgan, etc.). The rule would prevent banks from owning, investing, or sponsoring hedge funds or private equity, and disallow proprietary trading unrelated to serving customers. (Note, there's no "official" definition of a hedge fund—unlike a mutual fund—and what "serves customers" versus what doesn't isn't exactly crystal clear at the moment.)

If some form of proprietary trading restriction passes, it could very well mean commercial banks simply can't own or operate brokerage firms at all. They could perhaps do asset management only, but a significant portion of bank-owned brokerage earnings come from proprietary trading. In other words, commercial banks would likely revert to traditional banking—i.e., lending—to garner most of their profits. (Somewhat oddly, the government continues hammering banks to make more loans, while doing what they can to limit future profitable enterprise. Anyway...)

Before panic sets in, from what we could garner amidst the vaguery, we could end up with something like a Glass-Steagall redux. The original version, passed in 1933, separated commercial and investment banking—but was overturned in 1999 by the Gramm-Leach-Bliley Act (signed by President Clinton). Such an overhaul wouldn't be trivial and would certainly cause some near-term displacements as financial firms reorganize, spin-off, crack apart, etc.—but banks, brokerages, and insurance firms (and the rest of the world too) survived just fine for over six decades under Glass-Steagall. There's no reason they couldn't again. And breaking firms up might increase competition—likely more positive than negative overall. (Though for all you keeping track at home: The government "encouraged" Bank of America to acquire Merrill Lynch at the height of last year's panic to save the financial system—only to force their separation now. Also to save the financial system.)

Nevertheless, all this reform talk is par for the course for Financials this year. Remember, Sarbox was enacted in the wake of the Tech bubble and Enron-WorldCom implosions. It's normal after a major industry disruption and/or subsequent recession to see regulatory overreaching and missteps—one reason we continue to think Financials face continued headwinds for some time. It's likely these proposals, if passed (remember, the Democrats lost their supermajority not two days ago, and the dust has yet to settle) end up causing some good and some bad. And there will be plenty of unintended consequences—like, for example, if you think the SEC was overburdened before, adding 10, 20, or more firms to oversee won't lighten the load. But we won't know how all that shakes out until we see some actual bills emerge from the House and Senate—and until then it's all fruitless speculation.

Reading between the lines of President Obama's opaque speech did illuminate a significant point: His deliberate populist language shows, as of yet, he's learned little from the health care debacle and loss of the Dem Senate super-majority. It makes political sense to lay low after such a blow—not come out swinging, threatening to duke it out over a fairly significant financial reform. The harder the Democrats push, the likelier their power wanes come November. We hope the lesson's learned sooner, however—and with that moderation, a little less legislative uncertainty.


*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


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