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The second flaw is that Volcker appeares to have an outdated view of the financial system.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.