One ongoing critique of the Obama regulatory-reform plan is that it would enshrine too-
big-to-fail banks, making them not only invulnerable to regulators, but also invincible
against competitors.  It’s certainly true that the proposal doesn’t push to resurrect barriers
between commercial and investment banking nor does it set an arbitrary size threshold
over which banks would be banned.  But, what’s not in the plan on systemic risk is
dwarfed by what’s in it.  By imposing an awesome array of tough regulatory and capital
standards, the Obama Administration would create sharp downdrafts that force even the
current colossi of Wall Street to reconsider their combined charters.
Even if the plan is whittled down on the Hill, it’s a formidable challenge to any firm
under the aegis of the FRB, SEC or CFTC.  Proposals are in the works to implement as
much of the Obama plan as possible under current law.  This serves two purposes for the
regulators:  first, it begins reform for a large swath of the financial-services industry and,
at the same time, it changes the political dynamic in their favor.  The more big banks
come under tough rules, the more they’ll want them applied also to non-banks to share
the fun.  Given the scope of regulatory power over the biggest bank holding companies –
which now of course include huge investment houses – there’s little the Fed can’t do to
them if it wants to – and it wants to.  New law is only needed to cement the rules and
apply them evenly so that no one can get out of the systemic-risk fold through sleight of
legal charter.
So, if the rules are coming, why will they force a complete rethink of the consolidated,
diversified financial holding company?  The answer lies in the details of the Obama plan,
details written with the sure hand of seasoned federal regulators.  Key sections touch on
new capital standards, inter-affiliate transactions – yes, we know that sounds dull – and
activity restrictions.  Singly, big firms might be able to finesse these; together, they will
force formidable change.   

The new holding-company capital rules will include not only a tougher leverage
requirement – a first for new BHCs like Goldman Sachs – but also capital based on assets
on and off the balance sheet.  Regulators will also impose capital based on liquidity,
concentration and related risks, taking the toughening Basel rules and turning the dial up
more than a bit for the biggest BHCs.  Recall that equity positions held in a BHC are
already punished under Basel II and then think about what new rules sparked by the crisis
will look like for BHC proprietary trading – an activity the FRB wants out of the holding
company because, like Paul Volcker, it doesn’t think it ever should have been allowed
there in the first place as a profit center.
If capital doesn’t scare the systemic-risk boys – and it very much should – turn to the
discussion of inter-affiliate transaction restrictions also buried in the details of the White
House’s white paper.  If there is any doubt that the FRB and Treasury want trading out,
take a look at the recommendation to move OTC trading from insured depositories.  The
industry has focused a lot of energy on the broader derivatives reforms in the
Administration plan, but this recommendation – largely possible under current law –
would rewrite the OTC market at least as dramatically as the higher-profile proposals
starting to wind their way through Congress.  The banks’ biggest friend here will be the
OCC, but at the least new barriers within banks for OTC activities will be mandated if the
activity can be saved.   
Still unconvinced about the systemic-risk redo for the largest firms?  Then, take a look at
the activity restrictions.  Again, these bear Mr. Volcker’s mark, following through on
much in the Group of Thirty report he spearheaded (in collaboration with Larry
Summers) in the months leading up to the election.  The activity restrictions would take
any activity close to commerce out of any firm that tripped the systemic-risk wire.  In
fact, all parents of insured depositories would need to toe the line on current BHC
restrictions, confining parent companies to finance and limiting banks largely to
intermediation.  Think narrow bank and then suck it in some more.     
The activity restrictions are perhaps the toughest political sell in the systemic-risk plan –
even taking into account the furor over the Fed’s role.  The Administration is proposing
something Congress can rarely, if ever, bring itself to do:  take something away from
powerful interests attached to their holdings.  GE, for one, is already mounting a vigorous
push against the plan and its political might is not to be trifled with.
However, like other big non-bank banks, GE is fighting an uphill battle.  This results not
only because of the broader financial crisis, which might – just might – stir Congress to
take tough decisions.  More importantly, GE at the parent-company level isn’t as outside
the banking sphere as it likes to think.  It was among the very first to drink at the TLGP
trough.  The FDIC created this liquidity-guarantee facility to protect bank funding
sources at the height of the crisis, but instantly let GE take down more than $100 billion
in debt backed by the deposit-insurance agency.
Of course, GE isn’t alone among non-banks snuggling up to the rescue facilities
established by the banking agencies.  The FRB has allocated close to a trillion dollars in
various facilities aimed at calming markets, with many big users found at hedge funds,
private-equity firms and even manufacturing entities long deemed far afield from the
Federal Reserve.   
Although the Fed has started to shutter some of its facilities, it and the FDIC are far from
the back door on all of the backstops they rushed to put in place last fall.  Further, market
volatility means that both banks and non-banks may well be big-time back at the
backstop window.  Trying to persuade Congress that non-banks aren’t banks even as they
use facilities built into current law only for banks will be, at best, tricky.  This brings us
back to our conclusion:  very large firms that own insured depositories are in for a
strategic reconstruction from the regulators for sure.  This will force wholesale franchise
rewrites that redistribute the pieces on the banking game-board, reducing size, isolating
insured depositories and moving the traders’ desk – and that’s before Congress gets to