The Federal Reserve recommended Thursday that Congress act to get megabanks Goldman Sachs and Morgan Stanley out of the business of managing physical commodities and more generally to eliminate the practice of “merchant banking” in which banks invest or outright own nonfinancial firms.
In a report mandated by the 2010 Dodd-Frank financial reform law, the agency officially called on Congress to repeal the wrinkle in the law that allows just two banks, Goldman Sachs and Morgan Stanley, to store, transport and extract commodities, saying that those practices raise “safety and soundness concerns as well as competitive issues.”
Banks are generally prohibited from directly managing physical commodities businesses, but the two banks were grandfathered in through the Gramm-Leach-Bliley Act in 1999. A 2014 Senate report found that running those businesses exposed the banks to unique risks. For instance, Goldman Sachs was delivering uranium to nuclear power plants, an unusual risk for a bank. The investigation also raised concerns about possible manipulation of commodities trading markets.
Last year, Federal Reserve governor Daniel Tarullo told Sen. Elizabeth Warren, D-Mass., during congressional testimony that restricting the two banks from those lines of business would be one of the steps Congress could take to tighten the post-crisis Wall Street rules.
Thursday’s report made that recommendation official.
The Fed also calls for a repeal of merchant banking authority that allows banks to own nonfinancial companies, rather than lending to them, if doing so serves a financial interest. Owning certain businesses, such as commodities businesses, exposes banks and the banking system to unacceptable risks. Preventing such situations also helps “maintain the basic tenet of separation of banking and commerce,” the report said.
