Proposed banking rules in the news

US President Obama announced Thursday his idea for limiting what banks can do in an effort to prevent the wild risk taking that resulted in the financial crisis and ultimately this recession from happening again in the future. The new proposed rules would take away the ability for banks and financial institutions that own banks from investing, sponsoring or owning hedge funds or private equity funds. In the past (and actually the present as well) banks used their own money to invest in higher risk investments while the economy depends on them for taking peoples deposits and executing trades on their behalf. When the investments that these banks made for their own profit fail, it sends that bank and more importantly its customers who are individuals and small businesses reeling because they are no longer able to obtain financing needed to grow. Moreover, the government backs up these banks with taxpayer money because they are crucial to the economy’s continued growth, but for their intended purpose not their own side investment plans.

The President’s other proposed rule would limit the amount of deposits a financial institution can take from customers which would basically limit the size it can grow to. This would prevent large firms from merging and prevent them from becoming “too big to fail”. It is unclear what will happen with the ones that are already enormous in size.

The President makes some very strong and compelling arguments for his proposal. However, not everyone agrees with him. There are many other people that believe that this makes the financial system far less capitalistic and that can greatly harm the economy. Also, by preventing firms from earning profit it will not only mean that their shares and investors will be less profitable but it will make them less willing to loan money to individuals and small businesses, which is the exact opposite of what we need them to do. Those opposed to the ideas also argue that employing such significant limits will take the legs out of this very fragile economy. These people also have very strong and sensible arguments.

I think the best solution is the middle ground between the two sides, as is often the case. Some of the influencers in this decision making process have said that the President’s proposals are necessary and will help prevent another financial crisis, but stressed that doing all of them now would not be a good idea. Instead these rules should be rolled out slowly over a period of several years. This seems to make the most sense to me at this point, although I am not an economist. Perhaps they can start with not banning the banks’ investments in all hedge funds, private equity funds and other proprietary trading right away, but begin by putting some criteria as to which investments they can make such as lower risk ones. They can then tighten up these criteria over 4-6 years. This will allow time for the economy to strengthen and be able to absorb the blow and also not be overly intrusive. They can have a similar plan with their limit on how large a financial institution can be. They can gradually shrink the limit forcing the institutions to sell off assets little by little instead of breaking them up over night. I think this strategy will still do everything the President wants, which seems to make sense but will also do a lot for the people on the opposing side as it diminishes the risk of harming the fragile economy and allows the institutions to develop sound investment plans because they will know exactly what is coming and when. No one knows how this will all look like when the dust settles or when it will settle on this issue but, hopefully it will be a middle ground approach of some sort.