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Obama Must Flesh Out "Volcker Rule"

President Obama's proposed crackdown on the nation's largest banks is long on rhetoric and short on details. As a statement of intent, however, it represents a major ratcheting up of pressure on the financial industry.

"While the financial system is far stronger today than it was one year ago, it's still operating under the same rules that led to its near collapse," Obama said from the White House. "These are rules that allow firms to act contrary to the interests of customers, to conceal their exposure to debt through complex financial dealings, to benefit from taxpayer-insured deposits while making speculative investments and to take on risks so vast that they pose risk to the entire system."

"Never again will the American taxpayer be held hostage by a bank that is too big to fail," he added.

Obama's plan to limit the size of banks -- dubbed the "Volcker Rule" after economic adviser and former Federal Reserve Chairman Paul Volcker, who has lobbied hard for stronger bank regulation -- consists of two broad elements. Here's how the White House describes it:

  • Limit the scope: The President and his economic team will work with Congress to ensure that no bank or financial institution that contains a bank will own, invest in or sponsor a hedge fund or a private equity fund, or proprietary trading operations unrelated to serving customers for its own profit.
  • Limit the size: The President also announced a new proposal to limit the consolidation of our financial sector. The President's proposal will place broader limits on the excessive growth of the market share of liabilities at the largest financial firms, to supplement existing caps on the market share of deposits.
In his remarks, Obama framed the proposal as an extension of existing financial reform legislation currently before Congress. Nice try. Barring banking companies such as Goldman Sachs (GS) or JPMorgan Chase (JPM) from investing in hedge or PE funds and from engaging in proprietary trading goes well beyond anything the Administration or Democratic lawmakers have proposed to date.

Similarly, raising the specter of tigher antitrust limits on the financial industry could throw a powerful brake on industry consolidation, which has resulted in growing market concentration in banking. One possibility the Administration is considering is to raise the 10 percent cap on how much in insured deposits a single bank may hold.

One thing is clear: The President, perhaps eager for a legislative victory now that health care reform is in jeopardy, is training his fire on Wall Street. He's also seeking to harness public anger toward Big Finance from both the Left and Right, along with bipartisan support for curbs on the industry.

Indeed, depending on how the health care debate plays out, the White House may hope to pivot its entire domestic agenda to focus on rewriting U.S. financial rules. That would mark a significant reversal. After assuming office, Obama, along with Treasury Secretary Tim Geithner and chief economic adviser Lawrence Summers, appeared unwilling to directly confront Wall Street.

Still, major questions remain about the banking proposal. For one, does the Administration simply want to slow industry consolidation or does it favor halting it altogether? Or does it want to set back the clock by making banks divest assets that exceed the deposit cap? More broadly, is the intent here to reanimate the spirit, if not the letter, of Glass-Steagall by making financial companies choose whether to focus on traditional lending or trading?

This White House has preferred lay out broad policy proposals and let Congress fill in the details. In this case, that would be a mistake. Obama needs to seize the initiative by following up today's announcement with a concrete plan for cutting banks down to size.