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Volcker Plan Disrupts Crisis-Era Deals

Paul Volcker's plans to reform the financial systems would essentially render the big mergers brought on by the crisis moot if the proposal goes through in its current form.

Updated to include statements from testimony.



) - If Paul Volcker has his way, at least three crisis-era deals would be rendered a waste of time and money.

Volcker, a former Federal Reserve chairman who now leads the president's economic advisory board, is advocating for the separation of commercial and investment banking. Under his plan, large, diverse banks like

Bank of America

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JPMorgan Chase

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(C) - Get Citigroup Inc. Report


Wells Fargo

(WFC) - Get Wells Fargo & Company Report

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, would need to get rid of any businesses that engage in market activities for profit, or provide services for private entities that do, such as hedge funds and private equity funds.


Adding further layers of risk to the inherent risks of essential commercial bank functions doesn't make sense, not when those risks arise from more speculative activities far better suited for other areas of the financial markets," Volcker says in a recent

New York Times


Paul Volcker

The 82-year-old economic sage has advocated this idea for some time, but is bringing his message to the Senate Banking Committee Tuesday in support of the recent proposal by

President Obama

that would put Volcker's plan into law. He is scheduled to speak at 2:30PM EST.

In prepared testimony released ahead of the appearance, Volcker downplays the challenges of implementing his proposal. He says it is "not difficult" to identify the speculating trading arms that would need to be separated from commercial banks. He also believes there are "substantial grounds to anticipate success" in reaching an international consensus on the issue.

He focuses more on the necessity of the proposed division between investment and commercial banking. He notes that corporate America went so far in chasing profit that the division issue doesn't just exist within the banking industry. Volcker takes thinly veiled swipes at the bailouts of

American International Group

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General Electric's

(GE) - Get General Electric Company Report

finance arm, noting that one was a loosely regulated insurer, the other an industrial behemoth, but both received hundreds of billions of dollars in taxpayer support.

Instead, Volcker thinks the innovative products and speculative trades should be left to firms that can't rely on public money. In his plan, the private world of hedge funds and private equity would still face oversight. If a large firm were in danger, it would be allowed to fail in a process managed by the "resolution authority" proposed by the Obama team.

The idea of separating consumer banking from speculative banking lacks creativity -- it would

essentially reinstate

the Depression-era Glass-Steagall Act -- and it has virtues as a strictly pedantic exercise. But implementing the Volcker plan into modern-day banking would create great fissures across the industry and evaporate a good deal of shareholder and taxpayer money.

Bank of America isn't even finished integrating Merrill Lynch, but would likely need to hatchet off the entire business, along with its legacy investment banking arm. The acquisition was announced at a dire time for the financial markets, and has led to shareholder lawsuits, regulatory investigations and cost both banks some of their top talent, including B of A's recently retired CEO Ken Lewis.

The deal was also supported -- some would say forced -- by the government not long ago. When Lewis expressed doubts, Former Treasury Secretary

Henry Paulson

and Fed Chairman

Ben Bernanke

advised -- some would say bullied -- him to go forward.

Wells Fargo, too, would seem to have wasted a lot of time, money and effort if the Volcker plan is successful. Wells doesn't have a huge

prop-trading operation

, but think about how its acquisition of Wachovia might have gone if the bank knew it would have to get rid of all capital-markets businesses.

Wells initially courted Wachovia before the crisis had gotten so dire. It eventually made an offer to purchase just "certain banking assets" -- essentially branches with deposits and loans. But eventually, Wells bested Citigroup and won regulatory approval by

buying all of Wachovia.

Even after the merger was announced and progressing, Wells was still considering whether to sell Wachovia's large network of retail brokers and Wachovia's mid-tier investment banking business. But management ultimately decided that there was profit to be made on

Wall Street

, and retained the entire firm.

But imagine how the deal might have gone, had management known that Volcker's plan was afoot. Wachovia may have been left to fail, with Wells picking at the skeleton for branches and healthy loans, rather than coping with Wachovia's big book of toxic assets that remain a capital drain. On top of that, Wells may now need to spin off the very businesses and assets it agreed to envelop in order to win favor with the

Federal Deposit Insurance Corp.

The third crisis-era deal that would be rendered moot is the very first: JPMorgan Chase's acquisition of Bear Stearns. It's a blip on the radar in comparison to the other mammoth, government-prodded deals, and one that has largely been forgotten as the Bear placards were quickly removed and its legacy wiped away. But it is now part of JPMorgan's much-larger investment banking arm, which generates enormous profits and is a major-league competitor to white-shoe firms like

Goldman Sachs

(GS) - Get Goldman Sachs Group, Inc. Report


Morgan Stanley

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Citigroup, too, would be hobbled by the Volcker plan. Though the bank is still coping with sour assets and undergoing a restructuring process, management wasn't planning to divest all businesses that deal in the capital markets.

Citigroup is an international powerhouse that is known more for providing services to wealthy patrons and private trading firms across the globe than for taking retail deposits and making small loans. Its branch network is


compared to



Bank of America



, though its balance sheet is a similar size.

But for all that would be made moot by Volcker's plan, the plan itself may be even mooter, if you will.

Though Obama's proposal sparked a bank-stock sell-off, analysts and Beltway gossips were quick to point out its political roots. Some academics were also quick to point out that the issue it sought to address -- too big to fail -- wasn't the root cause of the crisis, and that Glass-Steagall was nullified for a reason. Bankers were quick to point out that it would result in a host of new costs and issues for the embattled industry to take on, and may create more problems than it solves.

All of those entities -- free-market conservatives, Volcker's scholarly adversaries, and the banking industry whose contributions fund election campaigns -- will be out in full force to oppose the Volcker plan. As an indication of its chance of success, not only has health-care legislation stalled, but even the Consumer Protection Agency, a proposed entity that would seem to have the most widespread support, may have to be shelved to pass a financial reform bill.

"We are not so sure that some of the Administration's proposals are slam dunks and while the headlines of these stories will be, in our view, negative for the largest banks, we think the political prospects for these proposals are at best muddled," KBW analyst Brian Gardner, who is based in Washington, said in his "D.C. Daily Dose" note recently.

In a political environment in which Obama's popularity is waning, Republicans are making headway, and as mid-term elections approach, it's unlikely that the glass wall of Glass-Steagall will be re-implemented any time soon, no matter how big banks get or how many of them fail.


Written by Lauren Tara LaCapra in New York