President Barack Obama unveiled new limits on US banks’ size and risk-taking, undoing the past decade of consolidation which created global banking behemoths such as Citigroup.
The President took a swipe at Wall Street banks as he announced the proposals, accusing some companies of returning to their old, pre-crisis habits and fighting White House attempts to overhaul financial regulation.
“My resolve to reform the system is only strengthened ? when I see record profits at some of the very firms claiming that they cannot lend more to small business, cannot keep credit card rate low and cannot refund taxpayers for the bailout,’ he said.
The Dow Jones Industrial Average had dropped by 1.8 per cent at lunchtime, hitting 10,411.16 points, amid fears that banking stocks would be hit by the new rules. The S&P500 lost 1.6 per cent.
The President proposed a limit on the amount of liabilities banks are permitted to take on, in an attempt to prevent banks from becoming so large that their failure would put the wider financial system at risk.
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It was not clear what the size limit would be but they would be on top of an existing 10 per cent cap on the share each bank can hold in the deposit market.
“There has long been a deposit cap in place to guard against too much risk being concentrated in a single bank” the President said. “The same principle should apply to wider forms of funding employed by large financial institutions.”
President Obama also said that deposit-taking banks would be prevented from owning or investing in hedge funds and private equity funds or undertaking proprietary trading, which is trading with the company’s own money.
“When banks benefit from the safety net that taxpayers provide, which includes lower cost capital, it is not appropriate for them to turn around and use that cheap money to trade for profit,” the President said.
“And that is especially true when this kind of trading often puts banks in direct conflict with their customers’ interests.”
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These rules are likely to impact Goldman Sachs and Morgan Stanley. Both traditionally investment banks, they became bank holding companies at the height of the financial crisis in 2008 in order to access discounted funds from the Federal Reserve.
Goldman Sachs is a successful proprietary trader, while Morgan Stanley, which has closed down its prop trading desks, owns and holds stakes in several hedge funds.
This morning David Viniar, Goldman Sachs’ finance director, said that the bank had not considered giving up its bank holding company status.
Goldman Sachs today unveiled a $12.1 billion net profit attributable to common shareholders. The bank maintained that proprietary trading made up only a small part of its revenue.
Morgan Stanley, which yesterday unveiled a $907 net loss, said at the time that it was reviewing its hedge fund investments.
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JPMorgan Chase, Bank of America and Citigroup, meanwhile, could be affected by the limit on size. JPMorgan has been particularly vocal in opposing any cap on the bank’s growth.
President Obama has asked the Senate Banking Committee, which is working on legislation introducing new financial regulation, to include the proposals in its bill.
The President wants to invoke the spirit of the Glass Steagall Act, which prevented commercial banks from undertaking investment banking activities and vice versa.
The Great Depression-era law was overturned in 1999, a move that has since been blamed for allowing banks that were entrusted with consumers’ savings to take huge risks on complex securities, necessitating America’s $700 billion bailout of the financial system.
Sandy Weill, Citigroup’s creator, was a key force behind the repeal of Glass Steagall. Citigroup survived the financial crisis only due to $45 billion loan from taxpayers after it plunged into mortgage-backed securities and other high-risk assets.
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Mr Viniar said this morning that it would be “pretty impractical” to return to Glass Steagall restrictions “in a world of global financial institutions”.
“Rolling back the financial system by 10 years will be a hard thing to do,” he said.
Shares of Goldman Sachs, Citigroup and Bank of America lost more than 4 per cent. Morgan Stanley dropped more than 7 per cent, while JPMorgan Chase & Co shed more than 5 per cent.