WASHINGTON — The age-old fight over whether banking and commerce should be separated is trending again, and banks are taking the brunt of it.

The sudden furor over Wall Street's ownership of commodity businesses — highlighted by a Senate hearing Tuesday and a New York Times investigation into Goldman Sachs' alleged aluminum price manipulation — is stoking calls for the Federal Reserve Board to close the door on such ownership schemes and furthering support for legislative plans to reinstate Glass-Steagall. And just on Friday one megabank, JPMorgan Chase, said it was considering selling off its physical commodities operation.

But while analysts expect some type of government response to quell the controversy, they caution that the options available to policymakers all have potential pitfalls, from giving nonbanks an unfair advantage in the commodities market to sapping that market of needed liquidity.

"The regulators will take some action and that will make" commodities "more expensive and take some profitability out of the transactions by requiring extra capital until banks find a loophole around it," said Kamal Mustafa, chief executive of Invictus Consulting Group and a former executive at Citigroup.

Federal law generally bans banks from engaging in nonfinancial activities, and commercial firms from doing retail banking. But the exceptions to that model have driven countless debates for decades. Most notably, Wal-Mart's many attempts — albeit unsuccessful — to do banking through a type of narrow-purpose charter that retailers can legally own led to intense efforts to strengthen the wall between banking and commerce.

But now the issue, for a moment at least, has shifted the issue in the other direction with some of the largest bank holding companies — including JPMorgan Chase, Morgan Stanley and Goldman Sachs — facing intense criticism for their ownership of commodities subsidiaries.

In just one week, megabanks' longstanding ties to warehouses and other infrastructure related to oil, electricity and other commodities has now led to accusations that financial institutions are unfairly influencing prices for their own gain and face additional safety and soundness risks from any potential hit to the commodities market.

Options for regulators to move forward include the Fed rethinking its policy that allows bank holding companies to own certain commodity-related businesses, under an exemption from the general ban on banks engaging in nonfinancial activities. The Bank Holding Company Act allows such exemptions for activities that are "closely related to banking."

But observers say the Fed has the leeway to rule that commodities do not fall under the exemption.

"It's very difficult to imagine the Fed … not taking action to change the bank holding company guidelines," said Isaac Boltansky a policy analyst at Compass Point Research & Trading. "It just feels this is something that can be done very easily from a regulatory standpoint and I think they will signal" their intention "to do so."

The controversy emerged early in the week after publication of the lengthy New York Times article, focusing on allegations that a Goldman Sachs subsidiary that owns aluminum warehouses was effectively driving up aluminum prices, and outspoken criticism of banks' commodity operations from Sen. Sherrod Brown, D-Ohio, who called for tougher regulation at Senate Banking Committee hearing.

"The Federal Reserve should issue clear guidance on permissible nonbank activities and should consider placing limitations on those that expose banks and taxpayers to undue risk," said Sen. Sherrod Brown, D-Ohio, in a call with reporters Wednesday, a day after the hearing.

Brown also called for the Commodity Futures Trading Commission to "crack down on anti-competitive practices" leading to higher aluminum prices, that are in turn hurting beer and soft drink distributors. He said he is calling for another hearing in September with regulators.

In addition to the Fed's authority to determine what activities bank holding companies can engage in, others said the controversy is lending credence to a legislative proposal by Sen. Elizabeth Warren to establish a 21st century Glass-Steagall framework, that would impose firewalls between an institution's commercial banking operations and riskier trading platforms.

"Bank regulators, including the Fed, may be incapable of effectively … overseeing complex financial investment conglomerates," said Saule Omarova, an associate professor of law at the University of North Carolina at Chapel Hill School of Law, at the Senate hearing. "Bank regulations are simply not geared toward controlling the risks of bank institutions acting like Enron."

But others said any steps to limit banks' involvement in the commodities market would have significant consequences.

"If you pull the banks out of the commodity business, you pull liquidity out of the market and you may see costs go up quite a bit," said Jeff Harte, an analyst covering mega banks like JPMorgan, Morgan Stanley and Goldman Sachs for Sandler O'Neill & Partners. "They're there for a reason and they're willing to take on a risk that your end users don't want to take on."

Mustafa, meanwhile, said severing ties between bank holding companies and commodities-related entities would simply allow institutions that do not do commercial banking to overtake the market.

If lawmakers "were to even succeed" in passing legislation to separate commercial banks from investment activities "it would kill our U.S. banks," Mustafa said. "If you take commodities away from banks, then you empower the remaining investment bankers and they would raise pricing."

Yet the counterargument is that a potential downturn in the commodities market, or even just a one-time event that forced a bank's commodities-related business to close, exposes the institution to risk that could hurt its commercial bank where it keeps deposits.

"If, in fact, we saw a catastrophic event at any of these owned facilities, nonfinancial facilities, the impact reputationally and operationally, not only to the institution but to the Federal Reserve, would be catastrophic," Joshua Rosner, managing director of Graham Fisher & Co., said at the hearing.

But Mustafa said a better option for regulators is to require banks to lock away enough capital to keep the traditional bank safe, and then any remaining capital can be used for investment banking activities at their own risk.

"It would work perfectly because the market has its own risks and when an institution doesn't have the capital, it won't work out," he said. "But the deposits are safe."

Mustafa said if policymakers effectively force firms to separate their commercial bank from other riskier enterprises to remain in the commodities business, the consequences would be dire.

"Within six months of Glass-Steagall's passage, Goldman Sachs would change from being a bank to being an investment bank so they can rape and pillage" the commodities market, Mustafa said. "And our banks will start losing all their global and multinational customers."

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.