The End of Wall Street as We Know It

After ignoring Big Paul for a year, Obama finally listened. The result is the end of Wall Street as we know it.

Surrounded by economic heavyweights called into the White House, President Obama announced today before the TV cameras that he wasn't announcing anything new. At least that's what his top administration officials indicated to the media in a "background" phone call intended to put the best possible spin on things. The administration officials declared that the new—whoops, I mean, additional—proposal today was in the spirit of what they themselves had already put forward last June and what the House and Senate, in consultation with the Obama-ites, had already inserted in their bills.

That's the official story. It's utter nonsense. The actual story is that today's proposal is totally new, far more radical than anything Obama and his top officials, mainly chief economic adviser Larry Summers and Treasury Secretary Tim Geithner, have proposed in the past. Indeed, they've been actively avoiding it for the better part of their first year in office. The president was gracious enough today to credit the man responsible for it—"we're calling it the Volcker rule after the tall guy behind me," he said—but what Obama didn't say was that, until now, former Federal Reserve chairman Paul Volcker has been virtually ignored by his administration.

Nearly a year before the president's announcement, Volcker had proposed barring major commercial banks that enjoy federal-deposit guarantees away from big-time speculative or "proprietary" trading—acting like a hedge fund, in effect, with taxpayer-backed money. When I interviewed Volcker about this last summer, he acknowledged that the president "obviously decided not to accept" his recommendations.

If adopted, along with another proposal to limit the consolidation of the financial sector into giant firms—essentially what's happened over the past two decades—Obama's new plan would dramatically change Wall Street as we know it. It would have an effect not unlike that of the Glass-Steagall law of 1933, which forced big banks like J.P. Morgan to spin off their investment-banking sides into new firms (in that case, Morgan Stanley).

Why did Obama decide to pursue this break-up-the-bank plan? According to the senior administration officials, he grew increasingly outraged by Wall Street's brazenness in going back to business as usual in the year since the crisis. "As we have come out of the crisis and seen major financial institutions make significant profits on their proprietary trading and using the [federal] safety net to do that," said one official, "it persuaded the president it was worth looking into this."

What he didn't say was that Obama's been losing altitude in the polls fast, and one of his problems is a perceived softness on Wall Street in the face of public outrage. In his remarks, Obama almost seemed to welcome the lobbying onslaught that's about to hit Washington as the banks seek to quash the effort (the major banks that would be affected by these rules, Goldman Sachs, Morgan Stanley, JPMorgan Chase, Bank of America, and Citigroup, dropped by as much as 12 percent in trading). "If these folks want a fight, it's a fight I'm ready to have," he said.

He's going to have a fight, a huge one. And as in the case of the derivatives legislation that passed the House late last year, the banks will seek to create loopholes that will allow them to do things as they have in the past. One big one may rest on the technical similarity between "market making" and "proprietary trading." The latter is seen as simple gambling with the firm's money. The former will be allowed, the administration officials said. "Yes, firms will be able to make markets, related to doing services for their customers," said one official. That means that the big banks will have to be permitted to buy and sell securities, Treasury bills, and other instruments in order to create a market in them.

Some experts believe that it's difficult, if not impossible, however, to distinguish market making from proprietary trading. "I don't think it's practical to think you can slice and dice classes of activities in any meaningful way," Volcker's onetime protégé, Gerald Corrigan, the former president of the New York Fed and a top Goldman executive official, told me last year. "Say you call me up and say you want to sell $100 million in Japanese sovereign bonds, or $100 million in GE 10-year bonds. You shop it around and go to five or six different [market-making] institutions looking for a bid. If I make the bid, there is at least a moment in time when I own it as principal [in other words, as a proprietary trade]. How are you going to distinguish these things? It's very very difficult."

How indeed? It's not clear the Obama team has thought through any of this and done more than "outline" a proposal, as one put it today.