Last week, President Barack Obama launched a historic campaign to restructure Wall Street. His ambition behind the proposal is to restrict the size, complexity and risk-taking capacity of the major U.S. Banks through an updated version of the 1933 Glass-Steagall legislation (which separated commercial banking and investment banking operations, lasting from 1933 until 1999).

His goals are to reduce the risk of another financial crisis, avoid future bailouts of failed banks, and stop banks from using depositors’ money for proprietary trading activities. Also, on his agenda is to regain support of the Democratic Party by siding with the American public over the Wall Street investment banks. In a recent survey, noted in the Globe and Mail, more than a third of Americans said that their attitude toward the banks would affect how they vote in the fall elections.   

The proposed regulation, known as the Volcker Plan, would impede commercial banks from: engaging in proprietary trading; operating, sponsoring or investing in hedge funds or private equity vehicles; and trading complex financial derivatives such as credit default swaps without oversight. The banks would still be able to trade securities on behalf of clients. Additionally, the proposal would enforce a cap on the market share of deposits and other liabilities held by any single bank.

The immediate and long-term effects of the proposed regulations would have a profound impact on the face of Wall Street. It would affect some of the biggest banks, including JPMorgan Chase & Co., Citigroup, Bank of America, Goldman Sachs and Morgan Stanley (the latter two only became bank holding companies at the height of the crisis to obtain access to cheap loans from the Federal Reserve in order to survive). For example, under the Volcker Plan, Bank of America would need to sell virtually all of Merrill Lynch and return to being just a retail bank.  Also, foreign commercial banks that operate in the United States will be faced with the same restrictions on speculative trading and size. The number of foreign banks with offices in the United States totalled approximately 700 at the turn of the millennium, controlling assets of $1.38 trillion.  This could decrease if the Congress passes Mr. Obama’s proposals, since these banks may move their business elsewhere. Some of the larger commercial banks in the U.S. have already started to shift some of their business to Canada and Hong Kong. These actions could potentially decrease the stability of the American economy on its road to recovery.

So where does this leave us? What will happen? What is the buzz on Wall Street? The plan requires the congressional seal of approval, which seems to be a key stumbling block to other efforts of Obama’s Administration regarding fiscal and healthcare reforms. In addition, the banks will become a strong counter-offense to the two parties running in the midterm election latter this year. Nonetheless, many parts of the proposal are sure to be watered down before they will be approved, especially since they may run counter to regulation in other countries.

Many believe from a political point of view, Obama’s bank-bashing move was wise. However, realistically the proposed regulations would probably not have prevented the housing bubble that was fuelled by cheap credit. Furthermore, we should note that some of the President’s concerns and problems have stemmed in part by Washington’s move to rescue collapsing institutions such as Washington Mutual, Merrill Lynch and Bear Stearns. The word on the street at the end of the day, bad lending practices cannot be legislated away.