The Man is Coming Down on the Banks

or at least, I hope he is. Paul Volker's NYT opinion article about limiting the sizes of banks. I don't really understand all of the recommendations since I have a limited knowledge of the financial system.

In particular I don't really understand this passage.

The specific points at issue are ownership or sponsorship of hedge funds and private equity funds, and proprietary trading — that is, placing bank capital at risk in the search of speculative profit rather than in response to customer needs. Those activities are actively engaged in by only a handful of American mega-commercial banks, perhaps four or five. Only 25 or 30 may be significant internationally.

The specific points at issue are ownership or sponsorship of hedge funds and private equity funds, and proprietary trading — that is, placing bank capital at risk in the search of speculative profit rather than in response to customer needs. Those activities are actively engaged in by only a handful of American mega-commercial banks, perhaps four or five. Only 25 or 30 may be significant internationally.

Apart from the risks inherent in these activities, they also present virtually insolvable conflicts of interest with customer relationships, conflicts that simply cannot be escaped by an elaboration of so-called Chinese walls between different divisions of an institution. The further point is that the three activities at issue — which in themselves are legitimate and useful parts of our capital markets — are in no way dependent on commercial banks’ ownership. These days there are literally thousands of independent hedge funds and equity funds of widely varying size perfectly capable of maintaining innovative competitive markets. Individually, such independent capital market institutions, typically financed privately, are heavily dependent like other businesses upon commercial bank services, including in their case prime brokerage. Commercial bank ownership only tilts a “level playing field” without clear value added.

I guess he's saying commercial banks should not also be hedge funds. I am gathering from the article that "capital market institutions" are hedge funds.

Here's a satisfying quote that I do understand, though.

I am well aware that there are interested parties that long to return to “business as usual,” even while retaining the comfort of remaining within the confines of the official safety net. They will argue that they themselves and intelligent regulators and supervisors, armed with recent experience, can maintain the needed surveillance, foresee the dangers and manage the risks.

In contrast, I tell you that is no substitute for structural change, the point the president himself has set out so strongly.

I’ve been there — as regulator, as central banker, as commercial bank official and director — for almost 60 years. I have observed how memories dim. Individuals change. Institutional and political pressures to “lay off” tough regulation will remain — most notably in the fair weather that inevitably precedes the storm.