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Senators debate tighter restrictions on bank investments

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Washington Post Staff Writer
Thursday, May 13, 2010

Nearly two dozen Democratic lawmakers are looking to tighten restrictions already included in the Senate's financial regulatory overhaul bill to bar banks and some other firms from making investments with their own money.

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Under the legislation being debated by the Senate, regulators could decide to restrict banks from using their own capital -- instead of a client's -- to make trades, known as proprietary trading.

But Sens. Jeff Merkley (D-Ore.) and Carl M. Levin (D-Mich.), as well as 20 co-sponsors, are pushing an amendment to prohibit banks from proprietary trading altogether. Under the amendment, other large financial firms would be allowed to engage in this trading but only in limited circumstances and if they set aside additional capital to cover potential losses arising from these trades.

Proprietary trading can produce significant profits for financial firms but has also been blamed for large losses at some companies during the height of the financial crisis.

The amendment is similar to what the White House initially proposed under the "Volcker rule," which reflects concerns about investment activities raised by Paul Volcker, a presidential adviser and former Federal Reserve chairman.

The measure has the support of Sen. Christopher J. Dodd (D-Conn.), the sponsor of the financial reform legislation, but it is facing stiff opposition from Wall Street. The issue of proprietary trading remains one of the few unresolved elements in the legislation lawmakers say could be approved by the Senate in the coming days.

"It is a fact that Wall Street keeps wanting to do business in the same way they were going it," Merkley said. "But what may be good for Wall Street profits may not be in the best interest of securing a solid financial structure. . . . If we do not change our practices, history will repeat itself."

But many in the financial industry argue that the proposal would unnecessarily limit some safe forms of trading. They urge that regulators be given the flexibility to restrict trading when they think best.

At the center of the debate is the question of whether such trading at large firms leaves the financial system vulnerable to upheaval. Citigroup, for instance, lost billions on such trades during the financial crisis and its former chief executive, John S. Reed, is now supporting the amendment.

"In 2007 and 2008, losses from risky proprietary trades in the major financial firms quickly decimated the availability of credit and seriously damaged the economy far beyond the concrete canyons where those bets were made," Reed said last month in a letter to Merkley and Levin.

But Douglas J. Elliott, an expert on financial policy issues at the Brookings Institution, said: "This wasn't by any measure the cause of the crisis for the banks. It was a small part of the issue."

Ken Bentsen, executive director of the Securities Industry and Financial Markets Association, warned it is hard to properly define proprietary trading and said regulators need to do more studies to determine whether any restrictions are needed. Noting that lawmakers have already said they're willing to let banks use their own money to buy U.S. debt or municipal bonds, Bentsen said other exemptions should also be considered, for instance trading in foreign currencies.

"That is going to take the regulators time to figure out," he said. "Some of this stuff is in a gray area."

The amendment also prohibits firms from betting against the securities they sell to clients. The "conflict of interest" clause was prompted, partly, by a Senate review of trading at Goldman Sachs. The Permanent Subcommittee on Investigations, which Levin heads, raised concerns about Goldman's practice of betting against its clients. Goldman executives have said there was nothing improper about that practice.

"There has to be integrity in the sale of securities so that you know that the group designing the securities is not working to undermine their value," Merkley said.

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