Recouping bailout costs by imposing a tax on banks is one thing, but the Obama administration's latest proposal would fundamentally alter the business of banking.
On Thursday, President Obama said banks are too big and too concentrated, and he asked Congress to bar banking companies from proprietary trading and from working with hedge funds or private-equity firms. The president also proposed curbing growth by imposing a hard cap on any one banking company's share of the market for nondeposit liabilities.
The president, with former Fed Chairman Paul Volcker at his side, blamed the industry's "irresponsibility."
"My resolve to reform the system is only strengthened when I see a return to old practices at some of the very firms fighting reform," he said, citing "record profits at some of the very firms claiming that they cannot lend more to small business, cannot keep credit card rates low and cannot refund taxpayers for the bailout.
"It is exactly this kind of irresponsibility that makes clear reform is necessary."
The president's proposals upend the debate on Capitol Hill over how best to reform the financial regulatory system. The White House outlined its goals last June and the House passed a bill that largely mirrored that in December. The bill is now in the Senate Banking Committee, where Chairman Chris Dodd, D-Conn., is trying to craft a compromise that will attract some Republican votes.
Dodd was with the president when he unveiled the proposals Thursday, but he didn't exactly embrace it, saying in a statement that he looks "forward to studying the president's proposal and will give it careful consideration as the Committee moves forward on financial reform."
Ironically, the panel's ranking Republican sounded more supportive of the president.
"The reality is some banks put themselves at risk," Sen. Richard Shelby said in an interview. "If you look at the banks that just focused on banking, they got themselves into a lot less trouble."
But plenty of people who observe the financial business for a living panned the president's ideas.
"What is being considered here is counterproductive, silly and vindictive," said Robert Albertson, chief strategist at Sandler O'Neill & Partners LP. "The problem isn't the banks. The banks are fixed. The problem is that credit is dead."
Jamie Cox, managing partner with Harris Financial Group in Richmond, Va., said limiting banks' piece of the nondeposit liability market is impractical and perhaps impossible, because it is a huge and varied global market.
"I don't think they are going to be able to," he said. "It's too big. This is not just U.S. This is global. This crosses lots of borders."
Sean J. Ryan at Wisco Research agreed.
"The proposal to extend market-share caps to liabilities beyond FDIC-insured deposits is extremely vague, and we wonder whether it is even workable," he wrote in a note to clients. "The pool of FDIC-insured deposits is well defined and generally known. Attempting to limit banks' share of other liabilities could quickly devolve into quasi-medieval debates over the nature and size of global debt markets."
Ryan, citing "the high ratio of posturing to specifics in the president's comments," wondered "how seriously these proposals are even meant to be taken."
"One thing about which we have little doubt is that there will be many more such proposals from now until November as politicians play to populist anger at the financial sector," he wrote.
It's true the administration did not release much in the way of specifics. It did not put a number on the cap that would be placed on a company's share of the market for nondeposit liabilities nor did it address the ripple effects such a limitation might have on say the Federal Home Loan banks or other providers. It also did not define proprietary trading, which many sources said banks do to some degree simply as part of the business they conduct for clients.
Keith B. Davis, an analyst with Farr Miller & Washington, noted that bank profits have relied heavily recently on trading. He said the biggest risk is that regulators will simply target all trading revenues given the blurry line between proprietary and nonproprietary trading.
"The ironic thing is the revenues [large banks] have been able to generate in the last two years in this area have saved them," he said. "They have been able to use these huge revenues in trading" to offset steep credit losses.
Ed Yingling, the president and chief executive of the American Bankers Association, said the plan would force the break up of large banks.
"If you look at it literally as proposed there are institutions that are engaged in these activities they would have to stop or unwind," he said. "I think that is what the stock market is reacting to now. They are showing the big banks are getting clobbered."
One of the hardest-hit stocks Thursday was Goldman Sachs, falling more than 4%, and it may have the toughest time complying if Obama's plan becomes law. It could escape coverage by getting rid of its bank, but doing so would cost Goldman access to the discount window.
That access is one of the first things the government provided when markets started crumbling in the spring of 2008, so a policy pushing investment banks to dump their banks may seem counterintuitive.
"You can do proprietary trading or you can own a bank, but you can't do both," said a senior administration official who briefed reporters on the president's plan.
The impact on commercial banks could be minimal, Cox said, because they derive most of their investment banking earnings from the fixed-income markets and advisory fees, rather than proprietary trading. "The more levered you are to the consumer, the less levered you are to proprietary trading," he said. "It seems to me this is more of a dare to get Goldman Sachs and Morgan Stanley to give up their bank holding company status."
The administration official did stress that the president does not intend for these policies to be applied retroactively.
"It's designed to restrain future growth," he said. "It's not about reducing liabilities within the … existing structure."
The president definitely struck a chord with some.
"Limiting the size and risk-taking abilities of our nation's largest banks will make the financial sector more accountable and more competitive," Heather McGhee, D.C. director of Demos, said in a statement. "The president has now drawn a line in the sand for Congress — stand with those greedy big banks that got us into this mess or demand transparency and accountability from Wall Street."
Bert Ely, a veteran observer of both the industry and its oversight, connected Obama's announcement Thursday to Republican Scott Brown's winning the Massachusetts Senate seat on Tuesday.
"The administration is trying to rebuild its political fortunes, especially after Brown's victory," the president of Ely & Co. said. "The president and his folks seem to think this big-bank bashing is the way to rebuild their polling numbers."
Paul Davis, Stacy Kaper and Matthew Monks contributed to this story.