* Departing exec's editorial calls out treatment of clients
* Reform advocates say shows need for tough Volcker rule
* Senator Levin hopes regulators heed the warning
* Unclear if it will impact regulatory thinking
By Alexandra Alper
WASHINGTON, March 15 (Reuters) - The Goldman Sachs resignation letter heard around the world has increased pressure on U.S. regulators to quickly put in place a tough version of the Volcker rule, that forces Wall Street to stop betting aggressively for its own bottom line.
Greg Smith became an overnight sensation when the Goldman banker published a withering resignation letter in the New York Times on Wednesday.
Smith described his former employer as a toxic Wall Street factory that only thinks about making money, mocking clients by referring to them as "muppets."
For reform advocates, the editorial showed that Wall Street failed to learn its lesson after risky trades brought global markets to their knees in 2008.
It produced fresh calls to finalize the Volcker rule, the provision in the Dodd-Frank financial oversight law that bans banks' proprietary trading.
Public Citizen, a consumer advocacy group based in Washington, D.C., issued a statement on Wednesday saying the financial industry had succeeded in getting regulators to delay putting the ban in place, and that Smith's editorial was a wake-up call.
"Smith's firsthand account emphasizes that each day of delay prolongs the abuse of Wall Street bankers over their clients," Public Citizen said.
The Volcker rule was tucked into the 2010 Dodd-Frank law late in the legislative process. It was seen as an additional way to ensure that banks cannot load up on risky trades that don't help clients and may even put the whole financial system at risk.
The rule bans banks that enjoy federal backstops, such as insurance for customer deposits, from proprietary trading.
However, it still allows banks to hedge their own portfolios and make trades that are done to serve the needs of clients, known as market-making.
Regulators have wrestled with how to distinguish proprietary trading from market-making, a dilemma that Wall Street has seized upon to push for a delay in the rule.
Federal Reserve Chairman Ben Bernanke has acknowledged a final rule is unlikely by the July deadline, and two Securities and Exchange Commissioners have said the proposal may need to be scrapped and reworked.
U.S. Representative Barney Frank, an architect of the Dodd-Frank law, said Smith's missive goes to the heart of the reform.
"The argument this guy is making supports the Volcker rule," Frank said in an interview on Wednesday.
"That is the distinction we are trying to make, that the financial institutions are there to service clients, not to serve their own ends," he said.
Senator Carl Levin told reporters on Thursday that Smith's "extraordinarily strong statement" embodied the spirit of his 2011 financial crisis report that called out Goldman Sachs for betting against clients on mortgage-backed financial products.
Levin, who authored the Volcker rule language in Dodd-Frank, said regulators should take the editorial seriously and not weaken the Volcker rule "because they are under bombardment by some of the same forces that opposed Dodd-Frank to begin with."
To be sure, the extra pressure does not get rid of regulators' troubles with crafting a workable rule.
They have 17,000 comment letters to go through, and Bernanke himself acknowledged there are "a lot of very difficult issues."
Karen Petrou, managing partner of Washington-based Federal Financial Analytics, says she is not surprised the column is being seized on to push the Volcker rule, but says she doubts ethical accusations will affect regulatory thinking.
A Wall street banking executive, who did not want to quoted, said government should be making decisions based on smart regulation, not emotion.
"It would be really horrible to make public policy based on one individual's allegations," he said. (Reporting By Alexandra Alper, additional reporting by Susan Cornwell; Editing by Karey Wutkowski and Tim Dobbyn)