Volcker says banks should not act like hedge funds

WASHINGTON — The federal safety net for commercial banks should protect depositors, not speculators, former Federal Reserve Chairman Paul Volcker told senators on Tuesday, urging them to pass the so-called Volcker Rule that would ban banks from trading for profit and that would restrict the size of the biggest banks.

Volcker, an adviser to President Obama, told the Senate Banking Committee that the system must be restructured to prevent a repeat of the bailouts of 2008.

The top Republican on the Senate Banking Committee, Sen. Richard Shelby of Alabama, initially said he was open to any idea that would prevent another "calamity," but, after the hearing, he said he was inclined to vote against Volcker's idea. He chastised the administration for "air dropping" its latest proposal months after debate had begun on rewriting the rules of the banking system.

Sen. Chris Dodd, D-Conn., said he "strongly supports" Volcker's proposal.

Banks must not be allowed to reap the benefits of successful speculation while handing taxpayers the costs of failure, Volcker said. Banks must not be allowed to own or operate as hedge funds.

Instead, commercial banks covered by the federal safety net should be restricted to the profitable businesses of traditional banks: operating the payment system, providing credit, helping customers manage their money.

Volcker said only four or five U.S. commercial banks and only a couple dozen worldwide engage in the kind of risky proprietary trading that would be banned under his proposal.

He didn't name them, but the firms likely on the list would include Bank of America, JPMorgan Chase, Citigroup, Goldman Sachs and Morgan Stanley.

In addition to the handful of commercial banks whose risks are taxpayer-subsidized, there are thousands of other hedge funds, private equity firms and other institutions that do not have taxpayer protection, yet are actively competing in capital markets, Volcker noted. "They are, and should be, free to trade, to innovate, to invest — and to fail.

"What we plainly need are authority and methods to minimize the occurrence of those failures that threaten the basic fabric of financial markets," Volcker said. "The essential need is to guard against excessive leverage and to insist upon adequate capital and liquidity."

But, "I don't want my taxpayer money going to support somebody's proprietary trading," Volcker said.

Commercial banks are covered by federal deposit insurance, access to the Fed's discount window for emergency loans to survive liquidity crises, and the knowledge that some firms are seen as simply "too big to fail." Other types of financial institutions are not explicitly insured by the government.

Volcker and Deputy Treasury Secretary Neal Wolin pressed the senators to toughen their proposals for financial regulatory reform to more closely match those already approved by the House.

"Our financial system will not be truly stable, and our recovery will not be complete, until we establish clear new rules of the road for the financial sector," Wolin said.

The Volcker Rule is meant "to prevent a banking firm from putting its clients, customers and the taxpayers at risk by conducting risky activities solely for its own enrichment," Wolin said.

The heart of the financial regulatory plan is the creation of a way to deal with large and systemically interconnected banks and financial firms that are on the brink of failure. In 2008, those failed companies were either bailed out, or left to die. Both approaches were unacceptable.

The administration's proposal would follow the model of the Federal Deposit Insurance Corp. (FDIC), which takes over failing banks to protect depositors and the payment system, without protecting management or shareholders. "In other words, euthanasia, not rescue," Volcker said.

AIG plans bonus

payouts of $100M

WASHINGTON — Bailed-out American International Group (AIG) said Tuesday it had begun paying about $100 million in early bonuses to employees of the controversial division that nearly bankrupted what was once the world's largest insurance company.

The early payments are part of a deal in which those workers voluntarily agreed to take about $20 million less than what they otherwise would be owed next month.

The company made the deal in an effort to avoid a repeat of the controversy that erupted in March when lawmakers learned of about $165 million in retention bonuses slated for employees of the company's Financial Products division.

In the bonus plan this year, AIG said about 97 percent of the active employees in the division agreed to reduce their 2010 bonus payments, to meet the company's "giveback target." The company owes about $198 million in bonus payments, according to government officials.

Los Angeles Times