Obama's Proposal to Place Restrictions on Banks

From thewhitehouse.gov:

The proposal would:

1.   Limit the Scope - The President and his economic team will work with Congress to ensure that no bank or financial institution that contains a bank will own, invest in or sponsor a hedge fund or a private equity fund, or proprietary trading operations unrelated to serving customers for its own profit.

2.   Limit the Size - The President also announced a new proposal to limit the consolidation of our financial sector.  The President’s proposal will place broader limits on the excessive growth of the market share of liabilities at the largest financial firms, to supplement existing caps on the market share of deposits.

My take: Limiting the proprietary trading operations, hedge-funds, and private equity funds could subsequently lower liquidity in the markets. The one thing that has irked me throughout this whole crisis is how much bad press trading operations receive. People sometimes lose sight of the vital role traders play in our economy --> they provide a market and they increase liquidity. Higher liquidity levels result in lower costs of borrowing for firms and increase the financial efficiency of our economy. Instead of highlighting these positives, the press focuses on their "excessive risk-taking" and their "risky bets fueled by greed." If this proposal were to pass, and that's a big if, then the subsequent fall in liquidity could pose a larger risk than
the financial firms themselves taking part in these trading operations in the first place! Of course, there is a lot of uncertainty about how liquidity would be affected, but it's clear this proposal would not increase it by any means.

The second part is a little more tricky. As for limiting the size of banks, the government cannot regulate the leverage, liabilities, and risk-taking of the banks better than the banks can, as long as the banks know they won't receive a bailout. The problem then becomes creating an environment in which no bank is "too big to fail." How do you do this? In this environment, I would like to know. I'd also like to know what the ramifications would have been were the government to let a bigger bank, such as a Citi or BoA fail, and further, whether they actually would have failed had the government not intervened. It's a shame we can't know the results both ways. There is no question that the government's intervention ultimately had a positive impact on the markets in the short-term, but the longer-term consequences have yet to be seen.

Ultimately, it seems like there is little support right now for this proposal and  I highly doubt it will get passed.