Volcker says trading by commercial banks encourages ‘too big to fail’

Prohibiting commercial banks from some high-risk trades should be an essential component of broader financial regulations and would cut back on institutions deemed “too big to fail,” former Federal Reserve Chairman Paul Volcker said Tuesday.

Volcker testified before the Senate Banking Committee, pushing new bank limitations on behalf of President Barack Obama. The Obama administration wants to add the restrictions on trading to legislation that would overhaul financial regulations.

Obama has embraced Volcker’s idea to prohibit large financial companies that have both commercial and investment functions, such as Goldman Sachs, from engaging in speculative trading. Large banks have said they oppose the idea.

Volcker said commercial banks, whose deposits are insured by the Federal Deposit Insurance Corp., should not be allowed to engage in speculation that does not benefit their commercial customers.

“Hedge funds, private equity funds and trading activities unrelated to customer needs, unrelated to continuing banking relationships, should stand on their own, without the subsidies implied by public support for depository institutions,” Volcker said.

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The ban would distinguish between commercial and investment banks — a separation that had existed until 1999 when Congress and President Bill Clinton repealed major provisions of the Depression-era Glass-Steagall Act.

The Obama administration’s stepped-up demand for tougher restrictions coincides with its call for new taxes on big banks to cover any shortfall in the $700 billion bank bailout fund.

The combined push is intensifying lobbying efforts by alarmed bank CEOs and complicating Senate efforts to write a bipartisan financial regulation overhaul.

Since health care legislation faltered in Congress, addressing the problems that led to the 2008 financial crisis appeared to be the Obama priority that had the best chance of success this year.

But negotiations in the Banking Committee are at a sensitive point. The hearing Tuesday was the first time the committee had met in public since Republicans pointedly rejected an overhaul proposal advanced by its chairman, Sen. Chris Dodd, D-Conn.

Dodd conceded that the timing of the administration’s proposal “had raised eyebrows.”

Sen. Richard Shelby of Alabama, the top Republican in the committee, complained that the idea “was air-dropped into the debate.”

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