Friday, January 16, 2009

Volker to Reign Banks In

Re-learning the lessons they learned back in the 1930s, which we ignored and undid from the 1980s on.

Group Led by Volcker Urges More Oversight of Banks (Update1)

By Alison Fitzgerald

Jan. 15 (Bloomberg) -- A group led by Paul Volcker, an adviser to President-elect Barack Obama, called for a regulatory crackdown that would curtail risk-taking by systemically important financial institutions and limit their share of deposits.

The panel of former central bankers, finance ministers and academics known as the Group of Thirty advised that regulators impose capital limits on proprietary trading and bar large banks from running hedge funds and private-equity firms that mix their own and their clients’ money. In a report released today, the group also urged governments worldwide to tighten supervision of insurance companies, investment banks and large broker-dealers.

The recommendations come as U.S. lawmakers and the incoming Obama administration consider ways to overhaul regulation after major financial institutions reported almost $1 trillion in losses and writedowns stemming from the credit crisis.

Volcker, former chairman of the Federal Reserve, said at a press conference in New York that he’ll make the recommendations to Obama, adding that the report is “a reasonable indication of the direction in which we might go.” He was named by Obama to lead a panel of advisers on how to pull the U.S. out of the recession.

The financial system has “failed the test of the marketplace,” said Volcker, 81, chairman of the Trustees of the G-30. He endorsed the recommendations as an individual and not as a representative of the incoming Obama administration, the statement said.

Volcker characterized the banking system using “a four- letter word: It’s a mess.”

Advisory Board

Volcker is set to be chairman of the President’s Economic Recovery Advisory Board after Obama takes office Jan. 20.

“The worst Wall Street financial crisis has gone global, and not a regulator worth his salt will back down from tightening up the regulatory regime,” Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York, said before the report was released. “Volcker has Obama’s ear and there is no doubt that the U.S. will be on the same page as most of these G-30 recommendations for greater financial- services regulation.”


Volcker’s report calls for clear distinctions between institutions, such as former investment banks, that deal mainly in capital markets, and commercial banks that take deposits and make loans.

“We are making a distinction between what appears to be institutions that are becoming larger and doing banking business,” Volcker said at a news conference in New York today. “They should give their loyalty to their clients and customers. Those functions should not be carried out in the context of an institution that is carrying out very risky capital market activities.”

He said the report seems to speak directly to news this week that Citigroup will sell off many of its businesses and that Bank of America Corp. has asked the government for an additional capital infusion to help it complete the purchase of Merrill Lynch.

“It’s been proven that they’re unmanageable, the existing conglomerates,” he said.

Not Glass-Steagall

Volcker said the recommendation fall short of a revival of the Glass-Steagall law that separated insurance, commercial banking and investment banking.

The 18 sets of guidelines call for greater transparency, stricter corporate-governance standards and tougher oversight of financial firms whose failure could bring down the financial system.

The goal is to “restore strong, competitive, innovative financial markets to support global economic growth without once again risking a breakdown in market functioning so severe as to put the world economies at risk,” Volcker said in the statement.

The group recommends that money-market mutual funds that offer banking services reorganize as special-purpose banks and submit to supervision. It also calls for government oversight and capital requirements for hedge funds and private-equity firms that are deemed “too big to fail.”

The report’s co-chairs were former Italian Finance Minister Tommaso Padoa-Schioppa, and Arminio Fraga, former president of the Central Bank of Brazil. The three principals said not all members of the group, which includes Bank of England Governor Mervyn King, TIAA CREF Chief Executive Roger Ferguson, and Bank of Israel Governor Stanley Fischer, agreed with the report.

Reining in Risk

The goal of the recommendations is to create a system that would avoid a repeat of the current financial meltdown by reining in risk and boosting oversight. The report is entitled “Financial Reform: A Framework for Financial Stability.”

“There were major failures in risk management to a point that is mind boggling,” Fraga-Neto said today.

The group recommends that money market mutual funds that offer traditional banking services reorganize as special-purpose banks and submit to supervision and that a systemic-risk regulator oversee and impose capital requirements on hedge funds and private equity firms that are deemed “too big to fail.”

“It’s quite clear that hedge funds can be big enough, and volatile enough to be systemically important,” Volcker said.

Credit Ratings

Regulators should also recommend a different payment model for credit ratings that would avoid the conflicts of interest inherent in the current system, in which major rating firms, such as Moody’s and Standard & Poor’s, are paid by the firms issuing debt, the group said. Companies that use credit ratings should seek independent opinions.

Some of the group’s recommendations, including the one regarding rating companies, jibe with proposals that Obama put forth during his campaign.

Obama has pledged to replace the government-sponsored mortgage finance giants Fannie Mae and Freddie Mac “with a structure that is engaged in helping people buy homes, not engaging in market speculation.” The companies were placed into government receivership in September. Volcker’s group recommends against “hybrids with private ownership and government sponsorship.”

Obama said he’ll streamline overlapping regulatory agencies, and that he wants any company borrowing from the federal government to be subject to regulation. He’s also looking to strengthen capital requirements on mortgage securities and derivatives, and require financial institutions to better disclose to investors and companies with whom they do business the kinds of assets they hold.

The G-30 report recommends countries “reevaluate their regulatory structures with a view to eliminating unnecessary overlaps and gaps in coverage and complexity” and it also calls for transparency in credit default swaps, and structured and securitized products.

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