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Economic Recovery Advisory Board Chair Paul Volcker looks on as U.S. President Barack Obama speaks about financial reform Thursday.

Charles Dharapak/AP2010

President Barack Obama is launching a historic campaign to remake Wall Street that threatens to throw the banking industry into turmoil.

Tapping into mounting Main Street anger, the combative U.S. President is proposing sweeping changes to how the industry operates, rules that would restrain the size and scope of the major banks and force them to choose between commercial banking and proprietary trading.

Mr. Obama's proposals, which must be approved by Congress, hark back to Depression-era measures and would turn back the clock on more than a decade of deregulation. The moves could force Wall Street giants such as JPMorgan Chase & Co. to restructure their operations, and threatens some of the banks' most lucrative lines of business.

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The controversial plan unveiled Thursday, partly inspired by the now-repealed Depression-era Glass-Steagall banking laws, comes a week after Mr. Obama proposed a hefty bailout tax on large financial institutions.

The announcement signals a renewed push by the White House to pass strict post-financial crisis reforms, which the U.S. Congress has watered down and let languish in recent months.

Investors read Mr. Obama's tough talk as a declaration of war on Wall Street, sending stocks of the country's largest banks tumbling.

The Dow Jones industrial average fell 213.27 points or 2 per cent to 10,389.88, and the TSX composite index lost 210 points or 1.9 per cent to 11,469.10.

Mr. Obama insisted he is now prepared to take on Wall Street after watching banks return to their old ways of excessive risk and bloated bonuses. He's also listening much more closely to his advisers, such as former Federal Reserve chief Paul Volcker, who have been quietly advocating a much tougher stance on financial reforms.

"Never again will the American taxpayer be held hostage by a bank that is too big to fail," the President said at the White House, surrounded by his top economic advisers.

It's still unclear exactly how the measures would play out on the Street, or whether Congress will embrace the crackdown in the face of the fierce and almost immediate pushback from Wall Street.

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Goldman Sachs chief financial officer David Viniar called the ideas "impractical" because they run counter to global deregulation.

"You have global institutions around the world who are set up in a certain way and to put rules in place that roll back the financial system by 10 years is going to be a very, very hard thing to do," Mr. Viniar said in a conference call.

While many banks may push back, the Obama moves may be more popular with others in the financial world, especially big investors. Many have long worried about the excesses that emerged after the 1999 repeal of Glass-Steagall, which had kept walls between the various branches of the financial services to avoid conflicts.

In fact, the proposals are in step with two recommendations last summer made by the Investors' Working Group, a panel of big-name financial thinkers created by two financial industry groups - The CFA Institute Centre for Financial Market Integrity and the Council of Institutional Investors.

That group has warned that "proprietary trading creates potentially hazardous exposures and conflicts of interest, especially at institutions that operate with explicit or implicit government guarantees" and that new rule are needed to "prevent the sector from becoming dominated by a few giant and unwieldy institutions." Proprietary trading is that done for the bank's own profit.

Kurt Schacht, a member of the group and the head of the CFA Institute Centre, said the White House push gives the reforms a boost.

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"The surprise is people were thinking that, with the rally, a lot of the urgency for regulatory reform had gone out of the sails because the industry had been successful in pushing back," he said.

Limiting proprietary trading won't be easy. If it's done too broadly, it can actually limit a bank's tools to manage and lessen the risks of their everyday business.

The Obama proposal appears to try to draw a line between trading that's done purely for profit and trading carried out on behalf of clients or related to client business. Mr. Obama also appears particularly troubled by what he has called banks taking positions that are "in direct conflict with their customers' interests."

While in some cases, it's clear that banks are just laying bets on the direction of interest rates or a stock, in other cases the distinction is much murkier.

For example, banks use a lot of trading to limit risks, which in the big picture is something that regulators have been trying to encourage. But that can lead to banks taking positions that, on the surface of it, may look contrary to what they are selling clients.

A bank, for a example, may have a large block of stock in a company.

It may be trying to sell that stock to investors. However, for the time being, if the stock goes down while it's on the bank's books, it could cause a loss. To limit that potential loss, the bank may take short positions, betting against that stock with other trades as a hedge. Similarly, a bank that lends a lot to the real estate industry may hedge against losses on those loans by betting against the industry in another manner.

Bank executives said bank customers will suffer if the Obama plan goes ahead - the same argument they made in criticizing the special tax on banks.

"The proposal will restrict lending, increase risk, decrease stability in the system, and limit our ability to help create jobs," warned Steve Bartlett, president and chief executive of the Financial Services Roundtable, which speaks for the big banks.

And yet many banks are already embracing some of the reforms on their own. For example, JPMorgan said in late 2008 that it would exit proprietary trading, and moved most of the people in the unit into other jobs on the trading floor.

Citigroup Inc. is also backing out of such businesses, selling its Phibro commodities trading unit even though it was one of the bank's most consistent profit generators. For that reason, many shareholders were critical of the sale.

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About the Author
National Business Correspondent

Barrie McKenna is correspondent and columnist in The Globe and Mail's Ottawa bureau. From 1997 until 2010, he covered Washington from The Globe's bureau in the U.S. capital. During his U.S. posting, he traveled widely, filing stories from more than 30 states. Mr. McKenna has also been a frequent visitor to Japan and South Korea on reporting assignments. More

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