I'm already tired of hearing the bleating from financial markets pundits that 'prop trading was not to blame' for the credit crisis. Prop desks are the tip of the iceberg that was once called an investment bank. Prop traders gauge the mood of the client trading going on in their own banks (Chinese Walls don't mean a lot between the prop and client facing desks - they are usually in the same room) and in others, take the trends and run with them, using a bucketload of the bank's money. Their interest and highly visible movements create demand for the products they favor - such as buying energy or commodities or taking short positions in banks that are about to fail. The client desks then get requests from their customers for instruments that they too can trade to get on board. ETFs and derivatives are created and securitized to enable this. The prop desks now have even more to play with - they can take the arbitrage between the underlying instruments and the ETF or derivatives and scrape off profit. They can employ high frequency trading tools to take the froth off the top of the more liquid markets. They know when their own interest in something is fading - the market is oversold or something is about to crack(cue CDOs) and short them while the bank still sells them to unwitting clients. There is no law against this. But the prop desks and client desks and market makers and internal hedge funds and private equity funds feed off of each other. It wouldn't work very well otherwise. When the LIFFE floor close in London in 2005 the dealers and floor traders lost their trading mojo, trading on the screen did not allow them to 'feel' the market. Trading floors today are the same. Most of the business is now electronic, but there is a buzz and a 'feeling' that comes from being in the same busy room. That can't be hidden with Chinese Walls or technology.
The proliferation of internal prop trading and hedge funds etc. came about due to pressure from outside forces. When stacks of traders were laid off after the dot com bust they started their own firms - HFT, hedge funds that could short client money, agency brokers with high speed platforms. The banks had to compete with this, which they did by building their own versions of them. And, although, prop trading did not kill the golden goose it was almost certainly what helped take the banks to the too-big-to-fail level.
I agree with President Obama (and since when is it OK to call him 'Barack' on TV? Bush was never called 'George' by the talking heads on CNBC). It is time to unscramble the eggs that are investment/commercial banks today. This is not politics, it is common sense.