Obama and Volcker Must Go After the Big Banks

Thus far, President Obama’s financial reform strategy has reeked of political expediency—talk tough to Wall Street, act gentle, ride out the populist anti-banker tide, hope for the best, change nothing. But Obama may have awakened to the smell of one-term coffee after last week’s Massachusetts Senate race results. It's certainly heartening to see Obama eschewing the advice of Wall Street-placating Treasury Secretary Timothy Geithner for that of the sager, former Federal Reserve Chairman Paul Volcker. Nevertheless, demonstrating the serious financial reform behind the political fluff talk will take more than a stint of administrative realignment.

Big bank stocks tanked after Obama rolled out the new Volcker rule, and mainstream media headlines attributed the declines to investor concerns that the crazy days of unregulated bank trading will be coming to an end. But the President's actual proposals were not enough to seriously rattle anyone on Wall Street. If anything, the banks were fretting over the prospect of losing the tag-team of Geithner and Fed Chief Ben Bernanke, whose joint brainpower has showered $6.4 trillion in subsidies upon the industry.

Anxious about his own political survival, Geithner rushed to warn us that the markets would be in worse shape if Bernanke were pushed out, a proclamation that put bank stocks back on the ascent—hooray for the bailout-backers! Geithner has spent years working as a lackey for our biggest banks and knows he's got "fall guy" written all over him, so he's been covering his tracks of late. (We'll see just how well at today's AIG hearing before the House Oversight Committee.) He'll be going on the offensive until someone on his own team decides he's expendable. It would be nice if Obama figured that out and chucked Geithner out before he deals out any more damage.

The until-recently-sidelined Volcker is a better fit for popular opinion. He has both criticized the insane subsidies the government is funneling to the financial sector, and offered serious, concrete ways to reduce the risks reckless banks foist on the public. But Obama’s Volcker-inspired proposal falls far short of the full Glass-Steagall resurrection that is needed to truly stabilize the financial system (along with a handful of other smaller-bore regulations).

Glass-Steagall barred the combination of risky, high-flying investment banking with boring commercial lending—accepting deposits and making loans. But Volcker's ideas only take aim at a relatively small portion of the risks embedded in the investment banking business.  As long as commercial lending and investment businesses remain intertwined under the same umbrella, financial behemoths will still be inclined to gamble their capital in securities trading rather than support the economy by lending to businesses and consumers. Given all the cheap money banks can currently get from the federal government, they have no obligation to do otherwise. When markets go up, securities trading is inherently more profitable, since, after all, the markets are up. For banks, the more trading they can do, the more easy profits they can score.

Volcker has always maintained that it would be difficult to explicitly break up the banks in a true Glass-Steagall sense. He has focused on ways to reduce their most obvious, unnecessary risk-taking activities and cut them off from some forms of taxpayer assistance in a bind. Yet Volcker would still allow boring commercial banks to perform securities underwriting, package mortgages into crazy securities and engage in risky asset lending—as long as these were "client-driven" activities.

What is "client-driven" trading? Well, it's the vast majority of what we ordinarily think of as risky trading activities.