Congress Examines Plans to Rein In Wall Street
Thursday, February 04, 2010

President Obama's plans to preclude the country's largest banks from running their own hedge funds and other proprietary trading activities have received the support of a key Senate lawmaker during their first examination by Congress, although now that the Democrats have lost their Senate 'super majority,' the proposals may have to be watered down if they stand a chance of becoming law.

During a hearing on the White House's proposals to rein in Wall Street, Senate Banking Committee Chairman Chris Dodd voiced strong support for the so-called 'Volcker Rule,' named after former Federal Reserve Chief Paul Volcker, who chairs the President’s Economic Recovery Advisory Board.

“The Obama administration has proposed bold steps to make the financial system less risky. We welcome those ideas,” said Dodd. “The first would prohibit banks – or financial institutions that contain banks – from owning, investing in, or sponsoring a hedge fund, a private equity fund, or any proprietary trading operation unrelated to serving its customers… I strongly support this proposal. I think it has great merit.”

During his testimony before the Committee, Volcker explained that hedge funds, private equity funds, and trading activities unrelated to customer needs and continuing banking relationships "should stand on their own, without the subsidies implied by public support for depository institutions."

"A number of the most prominent of those firms, each heavily engaged in trading and other proprietary activity, failed or were forced into publicly-assisted mergers under the pressure of the crisis," Volcker said. "It also became necessary to provide public support via the Federal Reserve, The Federal Deposit Insurance Corporation, or the Treasury to the largest remaining American investment banks, both of which assumed the cloak of a banking license to facilitate the assistance."

"What we plainly need are authority and methods to minimize the occurrence of those failures that threaten the basic fabric of financial markets," he added. "The first line of defense, along the lines of Administration proposals and the provisions in the Bill passed by the House last year, must be authority to regulate certain characteristics of systemically important non-bank financial institutions."

Apart from the very limited number of such “systemically significant” non-bank institutions, Volcker argued that the thousands of hedge funds, private equity funds, and other private financial institutions actively competing in the capital markets, typically financed with substantial equity provided by their partners or by other sophisticated investors, "should be free to trade, to innovate, to invest – and to fail."

"Managements, stockholders or partners would be at risk, able to profit handsomely or to fail entirely, as appropriate in a competitive free enterprise system," he said.

Sen. Richard Shelby, the ranking Republican on the Senate Banking Committee, has said that he is willing to consider any idea that would prevent a repeat of the 2008 meltdown in the financial markets, but with the Democrats now one vote short in the Senate of making legislation 'filibuster-proof,' a new financial regulation bill would likely need strong bipartisan support.