(Adds Volcker comments, details from bailout report)
WASHINGTON Jan 31 Failure to enact financial
reforms to curb large banks' risky activities and allow them to
fail without broad market disruptions will make the financial
system even more fragile in the future, Obama administration
adviser Paul Volcker said on Sunday.
In an opinion piece written for The New York Times,
Volcker, a former Federal Reserve chairman, said the United
States needs better protection against "outliers" -- a limited
number of mega-institutions whose failure would be "disturbing"
"The implication is clear. We need to face up to needed
structural changes, and place them into law," Volcker wrote.
"To do less will simply mean ultimate failure -- failure to
accept responsibility for learning from the lessons of the past
and anticipating the needs of the future."
Volcker wrote that during his 60-year career as a banker,
regulator and central banker, he has seen "memories dim" after
crises, and noted that there will be pressures to "lay off"
tough regulatory changes.
In the most recent crisis, bailout efforts that saved
several large institutions from collapse left a "residue of
moral hazard," Volcker wrote, implying that "really large,
complex and highly interconnected financial institutions can
count on public support at critical times."
The bailouts have given these firms a competitive advantage
in their financing, in their size and in their ability to take
and absorb risks.
"As things stand, the consequence will be to enhance
incentives to risk-taking and leverage, with the implication of
an even more fragile financial system. We need to find more
effective fail-safe arrangements."
A government auditor for the U.S. Treasury's $700 billion
bailout program also found that the bank rescues have made
reckless behavior more likely. A new report released on Sunday
by the special inspector general for the Troubled Asset Relief
Program said the bailouts have cemented a "heads I win, tails
the government will bail me out mentality" among investors in
banks that have feasted on taxpayer funds.
CURBS WON'T HURT INNOVATION
Volcker wrote that the Obama administration's proposal to
prohibit depository banks from owning or sponsoring hedge
funds, private equity funds and proprietary trading would not
harm financial innovation as some critics have complained.
There are currently only about four or five American
"mega-commercial banks" and about 25 or 30 internationally that
practice the three risky but lucrative activities, he said.
"The further point is that the three activities at issue --
which in themselves are legitimate and useful parts of our
capital markets -- are in no way dependent on commercial
banks' ownership," Volcker wrote. "These days there are
literally thousands of independent hedge funds and equity funds
of widely varying size perfectly capable of maintaining
innovative competitive markets."
Volcker also put in plugs for other Obama administration
reform proposals, including setting up a resolution authorities
to step in and liquidate or merge a systemically critical
company that is on the brink of failure. This should be coupled
with a "living will" that makes it clear that stockholders and
management stand to lose if the company fails.
He added that it was essential that the United States work
with other nations with big financial markets to reach a broad
consensus on reforms. "My clear sense is that relevant
international and foreign authorities are prepared to engage in
that effort," he said.
(Reporting by David Lawder, editing by Martin Golan and