Will Financial Regulations Have Desired Effect? What if anything will President Obama's proposal to rein in the big banks have on preventing further financial crises? Greg Ip, U.S. economics editor at the Economist, offers his insight.
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Will Financial Regulations Have Desired Effect?

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Will Financial Regulations Have Desired Effect?

Will Financial Regulations Have Desired Effect?

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MADELEINE BRAND, host:

And to answer some of the questions the presidents proposal raises, were joined by Greg Ip. He is the U.S. economics editor at the Economist magazine. Hi, Greg.

Mr. GREG IP (Economic Editor, Economist): Hello, Madeleine.

BRAND: Well, could you walk us through exactly what these reforms would mean for the banks? Give us an example with one bank, how would things change?

Mr. IP: Sure. Well, think about what a bank does. They do business on behalf of their customers. For example, theyll take a deposit from you to make a loan to me, or theyll buy and sell stocks and bonds on behalf of companies that need to raise money for investments and for, say, mutual funds and pension funds that want to invest in those stocks and bonds. They'll continue to be able to do that. But banks also trade stocks and bonds and other types of securities to make money for themselves. Thats what the new plan will crack down on. From now on, if youre a bank that has deposits and has the benefits of taxpayer protection for those deposits, you cant do that kind of trading for yourself, what we call proprietary trading.

The other change thats going to happen is that one of the main ways banks fund themselves is they gather deposits from ordinary customers. But under a law that was on the books since the early 1990s, no bank can have more than 10 percent of the deposits in the country. And so to get around that, banks can find other means of financing themselves. They can borrow in the bond market. Obamas plan would basically close off that loophole and make it that much harder for a bank to grow larger.

BRAND: So, would this in effect end proprietary trading?

Mr. IP: Its hard to say at this point. It probably will severely crack down on it because most banks will decide its not worth having the proprietary trading in order to they would rather stick with their regular customer businesses. And its hard to say at this point what effect it will have. But whats happened in the last 10 years and one of the reasons the administration has decided to tackle this is that a lot of banks got tired of the old, dull customer business of taking in deposits and making loans or buying and selling stocks and bonds on behalf of customers. And some, and Goldman Sachs especially, discovered they could make far more money doing proprietary trading. That line of business will basically be over.

BRAND: And a lot of people say, the president included, that that was the main reason for the financial collapse. Would this prevent future similar financial collapses?

Mr. IP: Probably not. There were so many causes to this financial collapse that it would be impossible to pinpoint one in particular. I mean, if you think of some of the firms that failed like AIG and Washington Mutual, they got into trouble by making loans to customers who couldnt pay them back. That wasnt proprietary. That was customer business. It just turned out that they made exceptionally bad decisions. On the other hand, one of the things that caused Bear Stearns to almost collapse was the trading of one of its proprietary hedge funds.

So, it would limit some of that risk taking. But there are many other types of risk taking that will discover. And its possible that the only thing that this will end up doing is pushing that activity out of the banks where regulators have a close eye on them into unregulated institutions, where theyll continue to pose risks to the economy, but we wont have a close eye on them.

BRAND: Well, a lot of people have said we need to return to the Glass-Steagall Act, which was dismantled at the end of the 1990s. Paul Volcker, who is advising the president, has been a big champion of that. So, is this what this is, a remantling, if you will, of Glass-Steagall?

Mr. IP: Not quite. I mean, what Glass-Steagall, which was passed in the early 1930s after the great crash in the beginning of the Great Depression, what it did was it separated commercial banking, which was taking in deposits and making loans from investment banking, which was underwriting stocks and bonds. Under Obamas proposal, investment banking can continue, you can still underwrite stocks and bonds if youre doing it for a customer. You just cant do it if its for yourself.

BRAND: And what does this all mean for you and me, bank customers, when we have our deposits in one of these big banks? What does it mean for us?

Mr. IP: For the typical customer, it shouldnt mean anything. You shouldnt see anything different at all, unless you happen to be a customer who owns one of their hedge funds, in which case, then you wont get to benefit from that hedge fund any longer. But for the vast majority of people who have bank accounts or who borrow because theyre a homeowner, a small business (unintelligible) bank, it shouldnt make any difference at all.

Now, what the banks argue is that its very hard to actually separate what they do on behalf of their customers, from what they do on behalf of themselves. And so this proposal can make it very difficult for them to properly manage their risk and that might hurt their ability to serve their customers.

BRAND: How likely will this be passed in Congress? Its part of a bigger financial bill that is currently stalled in the Senate. So, how likely is it that it'll get through?

Mr. IP: Right now I'd have to say that the odds are pretty low. What we saw as a consequence of the loss of the 60th democratic vote in the Massachusetts election is that any proposal by the administration that doesnt have bipartisan support is going to have a hard time getting through the Senate this year. And Republicans have already raised significant misgivings about a lot of parts of the presidents existing regulatory proposals. In particular, his plan to create a new consumer financial protection agency by adding in yet another proposal, it doesnt make it easier to get that thing past a Senate.

BRAND: Thanks very much.

Mr. IP: Good to talk to you.

BRAND: Thats Greg Ip. He is the U.S. economics editor at the Economist magazine.

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