Last updated: January 21, 2010 6:29 pm

Obama and US banks

When does client work cross the line into prop trading?

Simple question: how will President Obama’s proposals affect US banks? Unfortunate answer: no one yet knows. The new scheme – which covers a ban on proprietary trading, a ban on ownership, investment in or sponsorship of hedge funds and private equity, and new limits on the overall size of banks – is vague and will doubtless change before it becomes a reality.

The detail will make a huge difference. For example, pure proprietary trading – investment by the bank on its own, not clients’ behalf – at JPMorgan Chase contributes well below 1 per cent of revenues. But much client trading involves taking balance sheet positions and then holding them. So when does client work cross the line into prop trading? Determining what constitutes “sponsorship” of a hedge fund will also be crucial. Asset management vehicles that take short positions (and in which some banks invest alongside clients) could be affected. But lending and advisory services, such as prime brokerage and leveraged finance, seemingly will not be.


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The bottom line is that banks will have to choose between owning a deposit-taking institution, with access to emergency federal funding, and supposedly higher-risk activities. That suggests that Goldman Sachs and Morgan Stanley could relinquish bank status, avoiding major changes to their businesses and challenging regulators to keep tabs on them outside the bank system. The proposals, then, could be more arduous for the largest, integrated banks, such as JPMorgan and Bank of America, which could also face limits on their growth from a new cap on bank size.

This is not a return to Glass-Steagall. It is a targeted attack on specific businesses that the government does not wish to back. Yes, those activities can be risky. They will require regulation whether in or outside banks. They were also not the cause of most bank losses.

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