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Financial regulators move to fill in details of Dodd-Frank legislation

By Neil Irwin and Brady Dennis
Washington Post Staff Writers
Tuesday, January 18, 2011; 10:57 PM

The Obama administration and financial regulators took new steps Tuesday to rein in the size and riskiness of big Wall Street firms, aiming to fill in the details of the ambitious goals sketched out in financial reform legislation enacted last summer.

The largest banks would be forced to shut down risky operations in which they trade stocks, bonds and other securities for their own accounts under the proposals outlined in one study released Tuesday. The banks' chief executives would need to certify that the remaining trading operations are carried out for clients, not with the banks' own money. And a separate report recommends that no bank be allowed to account for more than 10 percent of the U.S. financial system.

The Dodd-Frank financial legislation, which President Obama signed in July, left wide discretion to regulators to figure out the details of how to increase oversight of financial firms and to carry out changes. The bill also created the Financial Stability Oversight Council, chaired by the Treasury secretary and including major financial regulators as members, to coordinate the policy.

At its third meeting, the council on Tuesday took the most extensive steps yet to turn the concepts in the legislation into regulations. The council released a study of how to implement the "Volcker Rule," which aims to prevent banks that benefit from a federal government safety net from making risky bets with their own money, and another analysis of how big a financial firm should be allowed to become.

A separate notice of proposed rules would designate large financial firms that aren't banks to heightened oversight. That could ultimately place large insurance companies, asset managers or other financial companies under the oversight of the Federal Reserve, if it is determined that "the nature, scope, size, scale, concentration, interconnectedness, or mix of the activities of the firm, could pose a threat to the financial stability of the United States."

The overriding theme of the three documents is that reining in risk-taking in the financial sector will not be simple.

"I think it was a recognition that this is going to be really hard," said Lawrence Kaplan, a banking lawyer at Paul Hastings, referring to the Volcker Rule. "There's a recognition that this is not a black-and-white rule and that it will be really challenging to monitor and enforce."

The impetus behind the Volcker Rule was to limit some potential losses at banks that can turn to the government for help if they get in trouble. Some large banks have already begun spinning off or shutting down their proprietary trading units ahead of the expected new regulations.

Regulators acknowledged Tuesday that they must walk a fine line in limiting proprietary trading without crimping acceptable banking practices, such as firms hedging their risk against swings in currencies or interest rates or trading on behalf of clients.

"While the mandate of the Volcker Rule is clear, crafting the necessary regulations will be a complex assignment," said Mary Miller, Treasury's assistant secretary for financial markets. She noted that proprietary trading often exists alongside transactions done on behalf of clients and the difference between the two can be hazy.

"This creates a gray area that will likely be the primary focus of supervisory review," Miller said. "The key challenge for the regulatory agencies implementing the Volcker Rule will be to define and limit proprietary trading without inhibiting market functioning and liquidity. . . . I think if we can provide that clarity to both sides, to the regulators and to the market, we'll find the right balance."

The oversight council also reported Tuesday that government officials have largely concluded a months-long examination into problems within the mortgage service industry that came to light in the fall amid reports of "robo-signing" and other shoddy practices. These could call into question the validity of hundreds of thousands of foreclosures throughout the country.

In February, "this task force should be in a position to provide a comprehensive report on its findings and what we propose to do about these problems," Treasury Secretary Timothy F. Geithner, the council's chairman, said Tuesday. Council members received a briefing on the investigative findings and the possible fallout from the widespread mortgage servicing problems in a private session before the open meeting, but those details were not shared publicly.

irwinn@washpost.com dennisb@washpost.com

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