The man with Obama’s ear

The mighty Paul Volcker, of course.

Wall Street was in a spin on Thursday as everyone awaited firm details on the Obama administration’s move to ban proprietary trading by deposit-taking institutions — an action that has inevitably been dubbed the Glass-Steagall sequel.

The President was due to formally announce the news after a meeting earlier with Mr Volcker, who is of course chairman of Obama’s Economic Advisory Board.

So here’s the former Fed chairman talking to Business Week just before the New Year in an interview with Charlie Rose. Extract:

Let’s talk about the financial system. You have said it failed the test of the marketplace.
Yes. It collapsed on us. And I think that’s the test of a financial system—is it facilitating reasonable stability and growth? No, it’s had a breakdown at great risk to the economy. It became dysfunctional, and it is still largely dependent upon government assistance.

How should we create a well-oiled financial system?
The kind of reform I’ve been advocating is acceptance of the fact that the core of the system remains commercial banking. If that breaks down then you have an enormous crisis. And commercial banks have expanded into areas I don’t think are so central. I would cut back their so-called capital market activities—hedge funds, equity funds, commodities trading, trading in derivatives. They’re all legitimate functions, but they’re not so central. And I don’t want to protect all those functions. I don’t want to protect everybody because when people act like they’re protected, you get in trouble. So let’s leave the capital markets to their own devices without any expectation of government protection and keep the existing safety net for the commercial banking system.

In my judgment we don’t need to regulate the capital markets so heavily. You have some extreme cases where individual institutions are so big and so vulnerable, yes, you might want some regulation of capital and leverage, but that would be the exception. But if they fail, let ‘em fail. We will have some kind of a new resolution process. Some agency will go in there and say, “You’re going to fail, but we’re going to provide a more orderly exit.”

But if you’re a commercial bank, no matter how big you are, you should not be allowed to fail? I wouldn’t go so far as to say you’re not going to be allowed to fail, but you’re going to have a lot more protection available so that it would take pretty extreme circumstances to fail to the point that the institution disappears. The quid pro quo for that is more regulation and a limitation on your activities. I don’t want [commercial banks] out doing a lot of speculative trading.

So does this mean we should restore Glass-Steagall?
No. That’s a false statement people make about my position. Glass-Steagall basically said banks cannot underwrite corporate securities or deal with corporate securities. But I would let commercial banks do underwriting of corporate customers. So you could argue that what I propose is somewhat in the spirit of Glass-Steagall in making a distinction between capital-market activities and trading activities and banking activities. But it is not specifically going back to Glass-Steagall.

Do you think that Congress will see it your way?
Eventually, yes. They need a little more persuasion.

That last point is important.

The snap political analysis of this is that it has pinned the Republicans in a position where they will have to spend the next 10 months in the run-up to the mid-term elections lobbying on behalf of Wall St.

In the US at the moment, that’s not a smart place to be.

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