Volcker Rule Being Deep Sixed

As readers may recall, we had argued over a series of posts that the proposed Volcker rule, to bar proprietary trading at commercial banks, did not go far enough in reducing systemic risk. While the concept was so sketchy that it was difficult to be certain what it meant, it appeared to have two serious flaws. First, it defined proprietary trading as only positions booked that did not involve customer transactions, such as private equity funds. This is a spurious distinction.

Separate proprietary trading operations are a relatively recent development, and plenty of speculation occurs on market-making desks. Gillian Tett pointed out that the so-called “trading books” were regularly abused in the run-up to the crisis (for instance, the large CDO positions, which were tantamount to proprietary positions, were held on customer dealing desks). Thus even with the Volcker rule, bad practices that played a direct role in the meltdown would continue to be backstopped.

The second flaw is that Volcker appeares to have an outdated view of the financial system. He viewed backstops as limited to banks, meaning depositaries. Yet in the crisis, emergency lifelines were throws to a host of non-banks: AIG, Goldman, Morgan Stanley, plus Bear and Merrill (via subsidized mergers). Bloomberg contended that Goldman and Morgan Stanley could continue to be bank holding companies, but would have to give up their banking subsidiaries, which would have a very limited impact on their business (for instance, a source who understood the operations of one major Wall Street firm estimated the rule would affect less than 1% of their activities). Reader MichaelC disagreed, arguing that Goldman booked its credit default swaps on the books of its bank subsidiary, so it would be troublesome and costly for them to escape; I checked with other sources, and they said it was too early to tell what the rule might really look like to tell.

All these debates appear to be moot. The Volcker rule is following the tried and true path of all Obama “reforms”, meaning an idea announced with great fanfare is being whittled back to meaninglessness.

The media are differing a bit on the particulars of how the neutering operation came to pass, but the general direction appears clear. The New York Post appears first out with the story (before reader howl, the Post has broken some financial stories and the discerning FT Alphaville picked up on this one, hat tip Richard Smith):

“My understanding is the White House really does believe in it, but Treasury and the Hill do not, so it’s not going very far,” said one person close to the Treasury Department.

Added another source, “the White House is looking to save face” by backing a proposal with fewer restrictions. “The administration will spin the compromise as a way to add safety to proprietary trading,” a source said. “But this is a fundamentally different approach to regulation [than the Volcker rule]…

Yves here. This is an intriguing reading of the dynamics. On the one hand, Timothy Geithner is so embattled that not only is he being interviewed in Vogue, but he takes a surprisingly defensive stance. Yet the Treasury engage in a turf war with the White House and wins. Or perhaps the climbdown is more a function of Congressional opposition (this change would require new legislation). The Senate Banking Committee made it abundantly clear it was not happy to see Team Obama retrading its financial reform bill at such a late juncture.

Bloomberg is running a story tonight that ironically shows some of the tensions between the White House and Treasury views, and offers some support for the Post’s reading. Notice these paragraphs:

One month after President Barack Obama said firms “will no longer be allowed” to trade for their own accounts, officials say they need flexibility to avoid impairing the $7.2 trillion Treasury securities market.

Dealers who trade in government bonds on behalf of clients need to be able to maintain inventories in their firms’ own accounts to insure market liquidity, said Lee Sachs, a counselor to Treasury Secretary Timothy F. Geithner. “This measure is not aimed at anything having to do with customer business, market- making or hedging,” Sachs, a former senior managing director in charge of debt capital markets at Bears Stearns & Co., said in an interview.

Yves here. Spoken like a true industry mouthpiece. As noted earlier, Sachs is trying to persuade the know-nothing chump public that anything that happens on a market-making desk is hunky-dory. I would bet that post mortems of Lehman would reveal that very little of the risk-taking that pushed them to the brink had anything to do with proprietary trading as defined by Sachs.

Similarly, the banking industry defenders are arguing that it would be hard to distinguish between customer and proprietary trading. That of course is meant to suggest that even that the Volcker rule construct, with its limited impact, should not go forward. But this notion again is misleading. The old joke of dealers is that a position is a trade that did not work out. Firms has simple-minded rules from the days of partnerships (when the owners were aggressive in watching risk-taking because they were personally liable for losses) to deal with this “whoops, I have a position I didn’t want” problem, as well as the other risk, of traders taking big bets that might bear watching. For instance, Ace Greenberg, who operated as Bear Stearns’ de facto chief risk officer, made traders dump any underwater position that was three weeks old. It’s worth noting that Bear came to ruin after Greenberg was excluded from a day to day supervisory role.

Yet while Treasury appears to be, um, clairfying the Volcker rule, the White House maintains its steadfast support:

Asked if the Obama administration is softening its insistence on the Volcker rule, White House Press Secretary Robert Gibbs yesterday said, “absolutely not.”

“We’re not walking away from, and we’re not watering down that proposal one bit,” Gibbs said.

Yves here. But in reality….

In negotiations with Congress, administration officials have focused on giving regulators the power to set limits and to design the program in a way that avoids market disruptions.

Yves again. Sure looks like the usual Obama double speak to me.

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  1. attempter

    This is getting old. (It was always old.)

    Announce an initiative with fanfare. Make a proposal (still just talking). Then do nothing and watch the thing be gutted.

    Public option, CFPA, derivatives reform, now the “Volcker rule”.

    By now it’s a moot point whether Obama is a criminal liar in all these cases and never wanted any of them, or whether he really does want one or more of them (he was definitely lying about the “public option”) but is too weak and cowardly and incompetent to get it.

    Either way it’s the same result, crime wins another victory, becomes further entrenched, and Obama is at the top of the list for who is to blame.

    (One can only scratch one’s head over those who continue to “believe” in this person. Even if you’re deluded enough to still believe in his good intentions, how can you deny the utter stupidity and impotence of his endlessly reiterated routine of making a loud proclamation of intent, and then after all the hype caving in completely in the face of the slightest resistance. There’s no course of action more contemptible than to keep on loudly announcing assertive intent and then out of cowardice fail to even try to follow through. Don’t we all despise people like that in day-to-day life? How much more repugnant is it in an alleged “Leader”.

    By now what can you say about those who still believe in Obama’s “progressiveness”? They’re liberal teabaggers, exactly as ridiculous and ignorant of reality as the rightists who call him a “socialist”.)

    Let’s say for the sake of argument this account is correct, Obama really wanted the “Volcker rule”, and Geithner has spit in his face over it.

    I especially don’t get the concept of “White House vs. Treasury”. I fail to understand it in principle. Treasury is part of the executive. Any president who has any competence and strength of character at all has a Treasury secretary who answers to him. In the end that’s a factotum just as much as any staffer or valet.

    So if it’s true that Geithner can run around setting his own line and even fighting Obama as if he were some independent branch of government, that’s yet another black mark on Obama’s wretchedness. He’s weak, he’s stupid, he’s incompetent.

    (A nominally powerful wuss like Obama usually comes up with self-justifications for his cravenness, so he must have some way to explain to himself why he’d let Geithner defy and oppose him. Since he was a constitutional law “professor”, I guess he must have some theory that Treasury is actually a fourth branch of government.

    I missed that part in the constitution.

    That must’ve been some class, where this clown was the teacher.)

  2. jbmoore61

    Mark Thoma picked up on the demise of the Volcker Rule, http://economistsview.typepad.com/economistsview/2010/02/prospects-for-financial-reform.html, and a commenter stated that egos in the Senate killed it due to poor politics on the part of The White House. If that commenter is right, then Obama and his staff are either horribly incompetent in introducing legislation to Congress, or cynically shrewd in appearing to be pro financial reform when they really aren’t. With all that has happened thus far, it looks like the former rather than the latter case.

    1. Yves Smith Post author

      This blog declared the Volcker Rule to be probably dead on arrival on Feb 1:


      But it continued to be debated in the media, which suggested there might be a rearguard action (yes I know, totally contrary to Obama’s well established pattern, but given Volcker’s sudden move to the foreground, one could not totally discount the possibility of changed tactics):

      http://www.nakedcapitalism.com/2010/02/goldman-morgan-stanley-can-escape-volcker-rule.html (Feb 2)

      http://www.nakedcapitalism.com/2010/02/how-the-volcker-rule-misses-the-shadow-banking-system.html (Feb 6)

      http://www.nakedcapitalism.com/2010/02/volcker-rule-gives-goldman-easy-choice.html (Feb 12)

      1. jbmoore61


        Please see the 0633 comment below. I was not implying that you were wrong about predicting the demise of the Volcker Rule early on. I only brought up Thoma’s post to show that perhaps the Senate Finance Committee killed it out of spite which you suggested was a possibility. If true, such an outcome suggests Team Obama political incompetence and impotence rather than cynical political manipulations which is a more depressing outcome actually.

  3. SA

    I’ve had a problem with Volcker rule from the start. It’s fine and good to say that there will be class of economic actors that are prohibited from government aid — and yet, three years ago, who believed that the investment banks could receive capital from the government? And to be blunt, there were rumors in late 2008 that SAC and other hedge funds were being considered for government aid. If CDS and related contracts are traded exclusively by HFs, does anyone really think that government wouldn’t step into prevent a domino effect of wealth destruction through cascading defaults?

  4. kevinearick

    the presidency has been a puppet job, as an interview to get part of the cartel gate for some time, and congress proved that it is obsolete once again.

    good for Tall Paul (heads I win, tails you lose) though.

    … and the dominoes pick up steam.

    1. kevinearick

      next we hear the old Roosevelt mantra about taxing the thieves to sprinkle a tiny percentage of the take back over the victims again, which didn’t work last time.

      poor economists are stuck repeating the past. what else can they do, but play it out?

  5. mp

    “…three years ago, who believed that the investment banks could receive capital from the government?”

    There were those of us who believed the Fed would exercise their authority to do just that.

    But, all of this is now academic. There isn’t going to be any meaningful reform and the next crisis–and there will be a next one–is going to take down the entire system. All of it.

    No apocalyptic thinking is required. It’s simple arithmetic.

  6. jbmoore61

    Is there comfort in being vindicated or acknowledged that you are right about an outcome when the outcome means that you and almost everyone else you know will suffer to a greater or lesser extent relative to rest of the populace? How does one not despair when there is such a disconnect between the perceptions of our elected politicians and the perceptions of the electorate? At some point, the people will revolt if they have suffered enough. Louis XV caused a financial crisis that resulted in the demise of Louis XVI and the French monarchy and government. Are we seeing the demise of the United States of America unfolding before our eyes? An impotent Executive Branch, a corrupt Legislative Branch, and a broken Judicial Branch pretty much mean that American society may have to start over with a new form of government just like the Founders built a republic from the ashes of the Confederation. Our current government is based on the second Constitution of the United States. Will we need to craft a third constitution?

    1. Yves Smith Post author

      I actually do not like being right, believe it or not, when things are this bad. I repeatedly say, “it would be better if I were proven wrong.”

      France had its revolution after ours. It had two empires, a restoration, and is on its fifth republic. So only having had two constitutions and one civll war is a very good track record, as much as that is cold comfort now.

  7. mp

    “Is there comfort in being vindicated or acknowledged that you are right about an outcome when the outcome means that you and almost everyone else you know will suffer to a greater or lesser extent relative to rest of the populace?”

    No, but I’m tired of hearing people say “Who could have known?”

    The fact is, a lot of people knew. Every CEO on Wall Street knew, and everyone three levels below them knew unless they were totally asleep or totally strung out on coke. The Fed knew. Treasury knew.

    They knew, and they did damn all about it.

  8. Sechel

    The Volcker rule made sense. John Reed himself testified bank managers know what proprietary trading is and the public debate about the vagueness of the term is strictly for public consumption. Truth is the Republicans are hanging out “opposing the measure” as a carrot to lure Banking money towards them and away from Democrats in time for the 2010 and 2012 elections

  9. bob

    Two choices-

    1. Attempt to fix the problems in the banks.

    2. Blow another bubble.

    There isn’t enough will power for number 1, or spending power for number 2.

    We can make the choice, or let it be made. The choice will be made either way.

  10. Andrey

    The Volker rule is completely insufficient and meaningless from its inception, equivalent to bailing the Titanic with a bucket. Wall Street does not add value. The entire financial system should be rebuilt as a regulated set of utility companies, like water and electricity. There is a big difference between working hard on socially beneficial endeavors and working hard in banking. Thus Apple produces iPods and bankers produce the illusion of profits (which they skim, or more accurately gouge all the more so after their vaunted financial engineering crashes). It is time to stop debating Potemkin financial villages (while the barbarians are raping us and our children) and start using blogs to radically redefine the systems.

  11. David Merkel

    The same ends of the Volcker Rule can be accomplished through adjusting the risk-based capital formulas — Equity-like risks should be funded through a 100% allocation of equity. Few banks would take on that level of speculation at that level of capital used.

    If you need proof, look at the life insurance industry. Companies used to hold a lot more equities prior to the tightening of RBC rules. Now they hold little, except at a few mutual companies that are flush with capital.

    For another off-the-wall idea: ban interstate banking, and let the states rule all depositary institutions. Results: No more too big to fail, and you get back “scaredy cat” regulators who don’t let banks deal in anything they don’t understand, which isn’t much.

    That also has preserved the insurance business in this crisis, leaving aside mortgage and financial risks, where the state regulators still have no idea what they are doing — that a proper reserve level would leave most of the companies insolvent today, but had it been implemented ten years ago, would have preserved the companies, but eliminated much of their profits.

    But Life and P&C insurers survive the process because of RBC, and “scaredy cat” state regulators. What a great system, which prior to the crisis, was criticized as behind the times.

    PS — if we ever get a national regulator of insurance, there will be a big boom and bust, much as in banking at present. It is easier to corrupt one regulator than fifty.

  12. MichaelC


    Regarding flaw 1. If you can substantiate your interpretation of Volcker’s definition of prop trading then you have a point, but I think you’ve still got it wrong. If your source can provide some evidence to support the ‘1% of activities’ claim, then we can review that data, but the 1% line sounds much like Goldman’s spin that prop trading is immaterial, when their trading book,(on various entities) is clearly significant.

    Volcker hasn’t defined ‘prop trading’ precisely (which I think was intentional), but it’s clear from his testimony and various interviews that prop trading = trading book.

    Regarding flaw 2. It is not clear that his definition of ‘banks’ is limited to depository institutions. It seems his definition of banks is much broader than that. If his definition of banks includes entities such as GS Bank, which is a (big) NY State bank (and G.Corrigan is the CEO for heavens sake), then your analysis of the ‘flaw’ is flawed.

    If Volcker’s aim is to immunize the commercial banking system from trading book risks at US Banks he can accomplish this in 2 ways

    1. Ban trading books
    2. Impose onerous capital charges on the bank trading books to drive the activity out of the banks.

    I imagine he is indifferent to the form it takes, as long as the substance makes it into the legislation.

    I’m sticking to the view that the loosely defined “Volcker Rule” was a tactical gambit to get substantial limits on trading activities at the banks implemented, and not a ‘return to halycon days’ fantasy.

  13. RueTheDay

    The Volcker rule itself was just a watered down reaction to those pushing for re-instatement of Glass-Steagall.

    If we get no Volcker Rule, no CFPA, no break up of TBTF institutions, and no derivatives reform, then what do we get? What’s left? Some vague legislation mandating greater transparency?

  14. Ben Garrett

    what ‘banking’ should do for our society

    Our comprehensive frame of reference regarding what ‘banking’ should do for for our society – what we require from it – remains glued in an irrational, clinically, perhaps cynically dysfunctional mindset.

    This public utility – which is what banking is, appropriately, intrinsically – is not something that, when functioning properly, is directed by entities who are autonomous; who have vested interests that eclipse the public’s. That ‘banking’ is treated any differently than regional electric utilities is due to systemic political corruption and captured oversight. This corruption perhaps eclipsed with the final destruction of Depression-era banking regulations so loathed by investment banking, smelling fresh meat: signed or celebrated by Robert Rubin, Phil Gramm, Bill Clinton, Larry Summers, Tim Geithner, the ‘Maestro’ Greenspan, inflationist Bernanke – all.

    We are presently instructed by Rubin luminary Larry Summers, Treasury clerk Geithner and money printer Bernanke that all we must do — is simply believe.

    The vision that we have been sold is that all we must do is borrow and ‘use’ all the newly printed $dollar markers. It doesn’t matter that the Administration is printing them out of thin air, because all the promises will be backed by the full faith and credit of the American taxpayer, and that will continue to mean something to those of us on this planet that are not American, who coincidentally also make the things Americans want, and collect our IOUs. As best I can tell, it appears to be simply assumed that regardless the level of currency inflation — that it will, effectively, never matter.

    Neo-conservative* economic theory that has dominated US fiscal policy for the last 40 years is predicated on the myth of perpetual growth. That growth would be driven largely through globalization: dominating weaker economies, controlling their markets, arbitraging their cheap labor, extracting their resources – returned to the homeland as bounty and plunder, permitting a synthetic level of consumption times greater than organically possible.

    Growth – preferably growth in the rate of growth – perpetually, every quarter, is perceived as both virtuous and divine, while also intrinsically irrational within our ‘closed’ planetary system and sociopathic in its resultant destruction. It’s also entirely mandatory – as a shark must consume to move to breathe to live to consume to move to breathe…

    As we may perceive now, without fresh ‘meat’ in – there is no ‘sausage’ out, no matter how fast the crank is spun.

    * … including, ironically by name, near-identical neo-liberal ideology of the earlier Kirkpatrick stripe and era.

  15. Cog

    Obama, and certainly every democratic president henceforth in this 60 vote world, is slave to the US Senate. He would be better off standing firm and pronouncing our Senate dead, then praying for a bill. It was as if Dodd were President when he reacted to the Volcker Rule screwing with his last shot at a legacy already pocked by AIG and Countrywide.

  16. Thomas Barton, JD

    The Volcker Rule may well suffer from many defects and is an incomplete remedy.. The true measure of its importance is that much effort has been expended to kill it. In many ways an accomplished con artist might well contend that the passage of the Volcker Rule would be akin to introducing any element of doubt into the mark’s head while the con is being run. Once the element of doubt has been introduced the entire efficacy and ultimate success of the con has been compromised, whether markedly, severely or fatally.

  17. MichaelC

    The Primary Dealer arms (which are in the broker/dealer) of the Consoldated Financial Companies are using the threat to future Treasury Auctions to pressure Treasury to kill reforms that will impact their “bank” arms. In the US Volcker’s plan will impair the trading operations housed in the banking entities (mainly their lucrative derivatives books).

  18. Atos

    Volker is a very well respected and experienced individual, but they basis of his proposed restrictions don’t achieve anything. It doesn’t matter what the origin of a transaction is, the risk to the system is the net risk on the bank’s books, regardless of whether that is prop trading or market making or facilitation. Not all market making or facilitation is zero net risk, so by definition, simply doing this so-called client based activity will generate a risk exposure. To try to distinguish risk based on the origin of the transaction is meaningless, it’s tantamount to saying for instance a 2% VAR exposure is fine if its facilitation, but a 0.5% VAR for an entity who has taken only principal positions with no net ‘client’ positions is no good. This is a silly way to analyze the situation. Any prop transaction has a counterparty who could be called a ‘client’ so the loopholes are many.

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