Agenda of the US is occupied once again with reform discussions. We are talking about comprehensive and well designed radical and systemic steps; not deceiving political steps. They have completed the health reform and how it is time to deal with the financial sector reform. It is correct that this issue was not much featured here in Turkey. In fact even the financial sector officials in the USA might be stealing a glance at the discussions not paying much attention and waiting for the talks to get serious. But I believe that we should as well start glancing at the discussions and developments already. Today let us put the issue on a framework; we can discuss the details next week. Let us see what President Obama tries to do on the way toward by-elections.  This by-election issue seems to be something that challenges the President concerning each decision he makes. We will learn tonight whether this issue will affect his April 24 speech. So let us talk about the reform discussions in the USA and the implications for Turkey.

April was a fortunate month for Obama. First, he signed and put into effect the Health Reform the Congress passed at the end of March. With the health reform law President Obama put into action an important income redistribution program. He put an end to the "Every man for himself" period that began with Reagan in 1980s. USA advanced upon the income inequality problem that prevailed over the last three decades. Taxes imposed on the rich were raised and poor people completely excluded from the health system were included into the system. Public insurance was implemented for the poor.

Thus, he introduced a law that will take from the rich and give to the poor and in the meanwhile save from health expenditures through some certain mechanisms. To be honest the mentioned low proposed an income redistribution program we have not been accustomed to see in the USA for a long time. So this initiative is important also in this sense. In fact, it separated the society into two large fractions. After all, the beneficiaries of the system did not constitute the majority of the society. But the President addressed the 'moral gains' such a system change will enable, pursued his campaign and succeeded. How did he succeed?  He constituted a solid ground for consensus and ensured the support of the majority. How he did it was as important as what he did. It appears that H.E. Prime Minister of Turkey who tries to teach 'corporate social responsibility' to firms - at least this is what I believe he tries to do - should see how things are done there. So, let this be the first point to underline.

And the second point: last week President Obama participated into a meeting where he declared his support for the financial sector reform. A columnist in the Washington Post known to be close to the Republicans commented on Obama's aggressive speech. The columnist argued that the impact would be stronger if a couple of handcuffed bank officials around. There, the comments are made only by columnists; the news itself is not given with subjective comments. Anyway, Obama eventually launched a campaign geared to implement structural measures against the practices that gave way to the crisis and against the practitioners of these. The campaign targeted at large Wall Street banks who hated the most. But what was the main purpose? What was Obama actually trying to do? It appears that Obama plans to take a radical step with the financial sector reform proposal just like the income redistribution effort he made with the health care reform proposal. This time the plan is to put constraints on banks' making transactions on their own account and behalf through a series of financial transactions. Transactions banks make on others' account and behalf (financial intermediation-brokerage) are tried to be differentiated from those banks make on behalf and account of themselves. At least this is exactly what 'Volcker Rule' for which Obama declared his support for in January 2010 targets. How it becomes apparent that this rule is involved in the proposal draft.

In the aftermaths of the 1930 crisis banks' making transactions in capital markets was totally prohibited. Banks had to establish a separate institution to trade in capital markets just like the intermediary agencies in Turkey. This is exactly where the investment banking industry in the USA originated from. This way, a Great Wall of China was build between banking and capital market transactions. This was actually the purpose of the 'Glass-Steagall Law' of 1930s. The Law was in force until 1990s. This time banks are not asked to differentiate their activities in capital markets by establishing intermediary institutions. The differentiation is asked for transactions on behalf and account of others and on behalf and account of the bank itself. But for which financial contracts will this apply?

For a while now banks have been doing three things at the same time in financial markets. First is the traditional banking activities; they collect deposits and extend credits. They finance real economic activity through credit contracts. They keep this credit portfolio mainly in their own balance sheets. Secondly they operate actively in the security markets. They contribute to financial system's securitization. They do this in two ways. On the one hand they directly help firms to issue securities. They help securities issued in the primary market to be traded in the secondary market. They provide the market with liquidity. In the meanwhile, they help assets, and financial contracts like securities, which cannot easily change hands due to their design, to be transformed into assets that circulate easily. For instance they change mortgaged real estate credits into securities. In order to provide liquidity for the mentioned two types of activities, banks not only intermediate the transactions on others' behalf and account but also carry out transactions on their own account. Thirdly, they carry out transaction on the behalf and account of others as well as themselves through a series of financial contracts that directly enable the transfer of risks. Financial contracts that divide all types of risk from swap transactions to any other derivative instruments into pieces are included under this category.

What is suggested with the 'Volcker Rule' is to put constraints on transactions on banks' own account and behalf for activities under the second and predominantly the third category. So, the discussion on the financial contracts to be covered will most likely be made for some certain transactions. What does this imply? What will be the outcome of the fall in liquidity for some instruments as a result of this attempt? It is also planned to improve the public disclosure standards for the second and the third type of activities as well as to increase the coordination between public institutions. Let us address these step by step next week.

This commentary was published in Referans daily on 24.04.2010