Volcker Rule: Dead on Arrival? And is Obama a Lame Duck?

We’ve argued that the “Volcker Rule,” which would limit “proprietary trading” by banks, is in theory a very good idea, but the proposal put forward by Volcker/Team Obama goes wide of the mark by defining any customer trade as not being part of proprietary trading. That’s a spurious distinction; large-scale position-taking well beyond what was needed for market-making dates back to the 1980s, long before firms had separate proprietary trading desks or in-house hedge funds. As a result, they looked likely to have little impact. As we noted:

You can drive a supertanker though the loopholes in this proposal, which are:

1. If a firm does not own a bank, it can do proprietary trading

2. Trades with customers are not proprietary trades

These are so silly that I’m astonished anyone is treating this proposal seriously.

Let’s dispatch them in order.

Whoever thinks that proprietary trading is just swell as long as the firm does not own a bank (meaning the kind that takes deposits) must have slept through the entire credit crisis (note I am not saying prop trading cause the crisis, but I guarantee there will still be readers who demonstrate in comments that reading comprehension is not one of their strong suits).

The implicit idea is that government backstops extend just to deposit-taking firms. That is patently ridiculous and is an attempt to hide from the public the reality of how the financial system works.

Thanks to thirty years of deregulation, a very large portion of credit intermediation (finance speak for the process of providing loans) has shifted from banks to the capital markets. As most readers know, many types of loans are originated by a bank, combined with other loans, turned into bonds, and sold to investors.

For reasons too long to go into now, bonds are traded over the counter (this is not a nefarious plot; there are legitimate reasons why). Over the counter markets have economies of scale, and in particular, network effects. So trading of credit market instruments, over, time, is dominated by a comparatively small number of very large firms.

Credit is critical to the functioning of any economy beyond the barter stage….. we have a world in which the credit markets are crucial to modern commerce, more so than banks…So any capital markets player of reasonable heft WILL be backstopped. That was the big lesson of the crisis just past and is not lost on the industry incumbents. Does anyone with an operating brain cell believe that if BofA divested Merrill and Merrill hit the wall again that it would be allowed to collapse? Look, we have twice had rescues of major non-banks, first LTCM, then AIG, due to the impact their failures would have ON CAPITAL MARKETS, not on depositors!

Clusterstock also noted:

But sources at three banks tell us that they are already finding ways to own, investment in and sponsor hedge funds and private equity funds. Even prop trading seems safe.

A person familiar with the operations of one big Wall Street bank said it expects that new regulation will affect less than 1% of its overall business.

But we also anticipated that even these weak measures would be gutted:

This is going to be very difficult to implement at this juncture, unless Team Obama has a purely regulatory solution. This should have been implemented months ago, when the banks were on the ropes and beholden to Washington. They are now emboldened and will fight tooth and nail. And the report at the Financial Times says the plan will require new legislation. Given how derivatives reform was gutted and health care reform was botched, what do you think the odds are that something with teeth will be voted in? Pretty close to zero.

And that is precisely what is happening. From the Financial Times (hat tip reader LeeAnn):
A proposal by former Federal Reserve Chairman Paul Volcker to limit bank’s proprietary trading will be either be dropped or significantly modified in the Senate…

Senate Banking Committee ranking member Richard Shelby (R-AL) said he opposes the so-called Volcker rule and the Obama administration’s call to levy a USD 90bn tax on banks. His comments come as House Financial Services Committee Chairman Barney Frank (D-MA) predicted the proposals outlined by President Obama could be law within six months.

…..Shelby said if Democrats push forward with the proposals they risk unravelling much of the bipartisan support already reached regarding the passage of financial regulatory reform in the Senate. Shelby said that the Obama administration risks losing Republican support for the bill if they begin to “politicise” the issue.

Now consider the broader implications: the Republicans don’t simply in theory have the votes to be intransigent; they have another vital element of the equation, party discipline. As James Fallows explains:

Bipartisanship in the American sense means compromising on legislation so that a sufficient number of members of Congress from BOTH parties will support it, even if (as is typically the case) a few majority party members defect and most minority party members don’t join. Bipartisanship consists of getting ENOUGH members of the minority party to join the (incomplete) majority in voting for major legislation. It can’t happen if the minority party members vote as a block against major legislation. And that can happen only if the minority party has the ability to discipline its ranks so that none join the majority, which is the unprecedented situation we’ve got in Congress today. (boldface theirs)

So take this situation to its logical conclusion. Obama can’t get anything done unless he accedes to the demands of the Republicans. And absent some sort of miracle between now and November, the Democrats look certain to lose Congressional seats in the mid-term elections. Is Obama already a lame duck? Now that may be going a tad far; after all, with nearly three more years in office, no one would question Obama’s authority to take action within normal Executive branch authority. But given Obama’s peculiar propensity to be seen as doing a lot, even when his “change” does not add up to progress, how is he going to react to the near certainty of being stymied on the domestic front? Will he seek to compensation by devoting more effort to foreign policy? Given his surprising and troubling surge strategy in Afghanistan, I’m not sure I like the possibility that Obama will try to score policy victories, and perhaps literal victories, abroad.

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  1. mitchw

    Did I not hear that Hillary is thinking about getting out of the Secretary of State job? Did not Johnson and Ford face primary challenges? Watch your back Barack.

    1. alex black

      Hillary had assumed that the Presidency was hers in ’08 for years. Bill didn’t appreciate having his image get turned from “the first Black President” to “racist” during the primaries. Can’t you imagine that they’ve been in the basement sharpening the knives for the last 18 months or so?

  2. alex

    James Fallows (as cited by Yves): “Bipartisanship in the American sense means compromising on legislation so that a sufficient number of members of Congress from BOTH parties will support it … it can’t happen if the minority party members vote as a block against major legislation.”

    So? The Democrats have the presidency and BOTH houses of Congress – including sufficiently large majorities to tolerate a few defections.

    The problem is the myth that you need 60 votes in the senate, even though 50 (+ the VP) is sufficient. Procedural filibuster? If Reid refuses to yield to another issue on the floor he can make the minority have a real filibuster, with cots, phone books, and the whole nine yards. If the minority was filibustering a truly popular bill then the Dems would look like heroes.

    We have a choice between an apologetically corrupt and ineffectual party or an unabashedly corrupt party. What a choice!

  3. Jon Sawyer

    “Bipartisanship consists of getting ENOUGH members of the minority party to join the (incomplete) majority in voting for major legislation” No, this is not bipartisanship — bipartisanship means crafting a bill that has elements that both sides will support.

    1. DownSouth

      With the Republicans, Obama could walk on water and they still wouldn’t support any legislation he proposes. They just keep moving the goal posts.

      Does Obama really believe he can reason with these people? Is he really that disconnected from reality? I think not.

      No, he’s just playacting, engaged in a finely choreographed script with the Republicans, each playing their assigned role, and designed to deceive and fuck over the American people.

      Remember Bush’s famous phrase “Bring it on!” If Obama were at all genuine, that’s the message he would send the Republicans.

      But that’s not going to happen, because Obama and the Republicans are on the same team.

      1. Reno Dino

        Got that right. Everyone in power gets co-opted by the Establishment. Even the stupid Tea Baggers who really are all about white power and not much else.

  4. Don


    You’ve neglected to mention what the Republicans actually want. You can’t just assume they’re evil just because they’re Republicans. Maybe what they want is a step in the right direction, maybe it’s not, but I wouldn’t know either way from reading this post.

      1. alex black

        Anyone who has raised children knows that much of the essence of responsibility is saying “No” when the children want to do ridiculous things.

        1. bob

          You assume that the children are the administration.

          Mine is that they are the republicans standing in the middle of the room pouting when asked a simple question, what would you like for dinner?


          Then the parent, in this case Obama, comes along and makes the decision for them. This is the power dynamic that most closely fits.

          I think most here would agree that some sort of action is required on banking regulation. No is not an answer.

          It leads to the majority simply doing what they want, and removes all dissenting views from the argument.

          No is not a platform, it is a whining little child.

        2. bob


          Brilliance from a comedian. He make some very good points and observations.

          The republicans could not even get a member of the FEDERAL government to do a rebuttal.

          The plans they point to are out of date, simplistic, and in most cases the same thing being proposed anyway.

          The site of the speach. The Virginia state house. This same stunt was pulled last during the civil war.

          I don’t agree with much of anything coming out of the administration, but I disagree with the lack of engagement from the other side more.

          1. DownSouth

            Let me match your comedy video with another.

            In this different ending to The Wizard of Oz from MadTV, Dorothy captures my sentiments perfectly, when she lashes out at Glinda, the Good Witch of the North: “You’re (Obama) so much worse than the other witches (the Republicans). At least I knew where I stood with them. You’re twofaced!”

        3. AP

          corruption is rampant on both sides of the aisle. our lawmakers are bought and paid for or they don’t get into office. to assert one ‘party’ superior is absurd.

          1. DownSouth

            That’s my take.

            If Obama were at all sincere or genuine, he could and would do the Terminator thing on the Republicans. And it wouldn’t be that difficult, given their mind-numbing stupidity and blatant dishonesty.

            But he doesn’t do it.


        4. rkka

          All the republicans propose are the same policies that wrecked the finances of our Federal government, like trying to finance two wars with tax cuts. That’s the only policy they ever propose, tax cuts, no matter what the situation is.

          There is a reason republicans went from having the Presidency and a majority of both Houses of Congress to having none of the above in four years, and that is their ideas simply don’t work, and they are utterly crap at governing.

    1. RueTheDay

      The Republicans do not want anything. They oppose reform on ideological grounds here, simply because it means increasing the sphere of government over private markets (regardless of the fact that this is exactly what is needed here).

      Their opposition to the bank tax is just the first step. They will oppose reform of compensation practices (it’s un_American to dictate pay!!!!!!), breaking up the big banks (why do you hate business???!!!), the creation of a special resolution authority (that’s socialism!!!!), and every other form of regulation.

      The Dems need to stop worrying about what the Republicans want, because all they want is to obstruct.

      1. koshem bos

        A reasonable summary of this unfocused exchange is to realize that the Republicans are a good reflection of the Talibans. They like wars, the love very rich and middle rich, they hate Obama as an invader of the palace, White House, that they see as theirs (they and the supreme court). They hated Clinton who basically flipped them the finger and hate even more the helpless Obama. They live in the 18th century although use the PR techniques invented by Goebbels. Every country has people like that, but in most countries they are less than 5% of the population.

    2. LeeAnne

      We have at least 10 years of proof that they’re evil. Don’t tell me that laying waste to Iraq, gutting FEMA and hiring the young and faithful to God and George W. Bush while attempting the destruction of the Justice Department, isn’t evil. The Republican perfection of pornography for use as a political tool is unprecedented in history EVIL EVIL EVIL

      Just look at the photo featured in Huffington Post today –pretentious soldiers for their corporate masters sneering over all the way over there on the far right.


  5. Jojo

    Maybe Obama gets pissed, says enough Republicans and declares martial law?

    Strange things arise from corners least expected…

  6. eric anderson

    “Given his surprising and troubling surge strategy in Afghanistan, I’m not sure I like the possibility that Obama will try to score policy victories, and perhaps literal victories, abroad.”

    I don’t know if the surge will work. I *am* sure I want him to succeed. Why would anyone not want him to score an actual victory? That’s what you’re supposed to do in a war! I guarantee this is one issue on which he’ll get some cooperation from the GOP. Maybe the only one.

    1. DownSouth

      Yea right.

      We’re going to “win” the war in Afghanistan.

      And if we cordon off the broker-dealers from the banks and fail to effectively regulate the broker-dealers, we’re not going to bail out the broker-dealers the next time they get in trouble.

      What other fairytales from the neocon-neoliberal playbook do you have to regale us with?

      1. eric anderson

        I’m sorry that you have to resort to labeling, which is tantamount to name calling. But if you insist, I am a paleo-con, so at least get your name calling right! :)

        Are we agreed that the surge worked to stabilize Iraq? Even Obama must think so, since he is implementing a similar strategy in Afghanistan. Of course the problem in Afghanistan is that unless Pakistan is brought to heel, we can not have success in Afghanistan. The Obama administration does not have the determination to get Pakistan under control, and therefore I agree with you, that Afghanistan is not winnable, in the sense that we cannot cure the terrorist problem there if the terrorists just move into Waziristan.

        My point is, who would not want to win the war? Who would fault Obama for trying to win it? Well, I’ll leave that an open question, but the answer is obvious. This is a long war, and it will not stop just because we give up. Don’t you remember, Afghanistan is the “good war” that everybody loved when we went into it? Why not finish the job? But again, re: Pakistan, Obama appears not to have the skill or the determination to force Pakistan to play their part.

        1. Dan B

          The surge in Iraq amounted to 1) the US bribing Sunnis to stop attacking US soldiers; 2) the ethnic cleansing of Baghdad; 3) the displacement of millions, either by leaving the country or becoming refugees; and 4) a media that does not report these conditions but is rather content to say “the surge worked”. And why call these occupations “wars”? Because wars are winnable? Bin Laden said he would do to us what we helped him to to the Russians. I do not like to insult people, but you are really and truly a thoroughly misinformed ugly American.

          1. DownSouth


            Just imagine the imperial hubris that inheres in a statement like “unless Pakistan is brought to heel.”

        2. DownSouth

          I’ll swear eric, what moronic right-wing talk show host do you get your talking points from? Rush Limbaugh? Glenn Beck? Sean Hannity? Bill O’Reilly?

          Anybody who points out the futility and/or immorality of the Afghan occupation gets hit with: “Why would anyone not want him to score an actual victory?” or “My point is, who would not want to win the war? Who would fault Obama for trying to win it?”

          Then there are great armchair warrior insights like this: “The Obama administration does not have the determination to get Pakistan under control…”

          Hello eric! The last time I checked Pakistan had nuclear armaments:

          We are trapped in an impossible situation in Afghanistan, with Pakistan sitting in the catbird seat, as explained here:

          For the wealthy nation, the probability of loss exceeds the possibility of gain and dictates its role as the defender. The unburdened opponent, enjoying the prospect of gain for comparatively insignificant loss, retains the initiative. He may endlessly alternate threat of action with pretense of compromise and continue no wise in danger of diminishment. When the utmost possible gain is achieved in this way, he may still attack at his own discretion.
          –J.M. Cameron, “Military Air Power: The CADRE Digest of Air Power Opinions and Thoughts,” compiled by Lt. Col. Charles M. Westenhoff, Airpower Research Institute, Maxwell Air Force Base

          But Pakistan’s position is even more enviable than this. Since its sins are sins of omission and not sins of commission—it just “looks the other way”—this gives it plausible deniability.

  7. Hugh

    It is not that Obama is a lame duck. What 8 years of Bush and 1 of Obama should teach us is that both parties have failed at and are incapable of governance. It doesn’t matter which party controls what. Overall the results are the same: militarism abroad, corporatism at home; a two tiered justice system: immunity for our elites, a sledgehammer for everyone else. It is all about looting whichever party is in power. The question is how long can the country function under such conditions and what will it look like when things fall apart. Will it be Japanification, depression, or revolution?

  8. Sundog

    The Volker Rule addresses legitimacy, not financial markets.

    Fallows is correct; the political process is broken. Volker understands that legitimacy is the issue for past, ongoing and future bailouts.

    Cheers to Tall Paul for the Tall Theatrics. Good luck with that.

  9. Paul Tioxon

    Is Obama a lame duck? When it comes to ad hoc legislation, special interest groups, like banking, will line up with who will work with them and the Republicans are happy to work against Obama and the Dems like an all out Tong War. When it comes time to have someone in charge again, do you see someone like Sarah Palin, in the WH with exactly what crowd surrounding her? Goldman Sachs chieftans, Harvard economists of the right tint and hue? Or Lafler Curve specialists, gold bugs and members of The Family abolishing dinosaur exhibits from National Park brochures. Did I forget about the Terry Schiavo prayer vigils for resurrection by the Holy Spirit? The money that put him in, wants him to stay there to clean out the barn before anyone appropriate of Republican side returns. The battles that go on, go on because, just as the execs of Wall Street run their imperial franchise, the federal government, and the President of the United States runs his.

    The elected politicians behave similarly to executive management that have hijacked the corporations they are supposed to run for the shareholders for their own aggrandizement. Different sector same imperial behavior. I do not see him Obama going anywhere. He has tremendous, savy support, and money. MoveOn alone has 5 million members, a great portion of which give money monthly. Not to mention their internet communication and organizing infrastructure. It makes the tea bag groups look like a church bake sale in comparison.

    1. alex black

      Oh, Lord. Is the best economics blog on the Web going to turn into one more site where people gather to scream obscene names at those who disagree with them politically? Let’s make a deal – I won’t call Obama a raging Trotskyite if you don’t say that because I oppose increasing taxes for redistribution, I spend my evenings dangling my testicles in other people’s mouths (just in case you didn’t know what “tea-bagging” means).

      However, we’re all free to speculate on Bill and Hillary’s respective sex lives. 8-)

      1. LeeAnne

        Odd That. I see a lot of disagreement over policy and twisted language that amount to lies for popular consumption.

        You can talk about testicles all you like -its so Republican porno porno porno

      2. Anonymous Jones

        I’m all for dropping the name calling, and I am not going to judge you as being ‘evil’ or even misguided regarding the opposition to “increasing taxes for redistribution,” but I will say that if you think we polled all 300+ million American and that more than 50% would agree with your opposition, you are delusional (in an objective, non-pejorative sense…sorry if you think the connotation is normative). The only way your worldview can prevail in a democracy located in “Extremistan” is through obfuscation and the power of wealth. There is nothing inherently ‘wrong’ in your position; it’s just that I don’t agree with it and neither does the majority.

  10. marcello

    how truly screwed up is your country ? Since when is 59% NOT a majority ???

    All this talk of needing 60% to get anything done is simply unbelievable. The ONLY thing that makes sense is that the gov’t really doesn’t WANT these policies to go through, and uses the 60 seat rule as a convenient skirt to hide under. nothing else makes any sense

  11. Rob Spencer

    “I guarantee there will still be readers who demonstrate in comments that reading comprehension is not one of their strong suits”

    Nice. Is the kind of respect you have for your readers demonstrated by this bitchy statement? Count me as not one of them.

    1. Yves Smith Post author


      How often do you read comments in blogs? Virtually every post I write has at least one commentor misread something stated clearly in the post. I also see this at every blog that has more than a comment or two in its comment section. I infer a lot of readers merely skim an article, see a phrase in isolation, and go off in comments to bitch. I’ve been getting this for well over two years, and a single comment on this phenomenon is hardly out of line, particularly when I make a remark that is likely to elicit precisely that sort of response.

      No one is holding a gun to your head to read this blog.

      1. Dan Duncan

        Please folks, let’s stay on topic–which is whether there should be more regulation of proprietary trading.

        My personal feeling on this is issue: As long as the firm does NOT own a bank, then proprietary trading is swell.

        1. LeeAnne

          I guess you mean energy derivatives like those so cleverly managed by Enron; maybe you mean insurance companies like the American International Group also known as AIG or perhaps car companies like GM -GMAC anyone?


          “Is General Motors a bank or a car maker? Since its public downfall in December 2008, General Motors has received $12.5 billion in government aid. General Motors Acceptance Corporation is harboring a huge debt in the credit derivatives marketplace which is a major obstacle toward GM’s overall capability to be profitable. To finance its continued survival into 2010, the conglomerate has been unable to raise private or other Wall Street capital. GMAC was considered too big to fail and now taxpayers are entrenched in the debacle, in large part due to unrestrained questionable credit and banking practices, not simply auto manufacturing debt issues.

          GMAC is a United States bank holding company that was previously the wholly owned financial services arm of General Motors. GMAC Financial Services provides a host of financial programs including insurance and mortgage operations in approximately 40 countries around the world. In 2008, the firm provided financing to 75 percent of the 6,450 GM dealers. On 24 December 2008, the Federal Reserve accepted GMAC’s application to become a bank holding company in order to gain access to billions of dollars in government aid, a crucial attempt to ensure the survival of the company.”

          1. LeeAnne

            Maybe you mean manufacturers like General Electric Co. Maybe you missed this Businessweek article

            Former GE Capital Manager Is Target of Muni Derivatives Probe
            January 14, 2010, 02:41 PM EST
            More From Businessweek

            By Martin Z. Braun

            Jan. 14 (Bloomberg) — A former manager at a General Electric Co. unit is a target of a federal criminal probe into bid rigging of investment contracts that states and local governments use to park proceeds from municipal bond issues.

            Peter Grimm, who oversaw municipal investment contracts at General Electric Capital Corp.’s Trinity Funding Co., is one of a dozen salesmen or brokers who are targets of a criminal investigation of the $2.8 trillion municipal bond market, according to records on file with the Financial Industry Regulatory Authority and state securities authorities.

            In October, federal prosecutors indicted Los Angeles broker CDR Financial Products and three of its executives on antitrust and conspiracy counts, the first charges resulting from a more than three-year investigation.

          2. Dan Duncan

            LeeAnne. Take a deep breath.

            It was a joke.

            There is a certain irony to your responses, though…especially since the underlying issue was reading comprehension.

  12. Don

    The part I don’t understand is that the post makes the case that the proposed Volcker rule is toothless, but then lambastes Republicans for opposing it. And most of the comments seem to think this makes perfect sense. Am I missing something here?

    1. Yves Smith Post author

      What is the point of opposing a rule that is so weak (in terms of its practical impact) as to have no effect? It appears to be mainly for theatrics, to score points, or, as bob said, to say “NO” because “NO” is policy.

    2. Dan Duncan

      It’s just a toddler’s version of The Liar’s Paradox. This infantile brand of Republicanism, out of power and out of options cannot even resort to simple lying. All that’s within their influence of control is the ability to say “No!”—just before taking a deep breath…and holding it.

      Definitely makes for a herd of anorexic elephants. [Of course, the obscenely obese Dems dumping all over DC balances things out in a paradoxical way.]

      Here’s a way out, though:

      1. Republicans exist to vote “No” on all legislation proposed.

      2. Legislation should be proposed on whether Republicans should exist.

      3. Repubs will vote No, and therefore no longer exist.

      Unfortunately, this group of Dems would then turn around and propose the following:

      Republican Asset Relief Program (RARP)

      “$1 Trillion will be set aside to safeguard the existence of the Republican Party. The redistribution of these funds will be distributed to these members of Congress so long as they:

      1. Send our country to needless wars, which we will initially approve and then disapprove.

      2. Blow-up the size of our government, while claiming to be the Party of fiscal responsibility.

      3. Ensure a fractured voting base by engaging in an endless series of inane cultural debates about Gay Marriage and Stem Cell Research.

      1. DownSouth

        That’s what happened here in Mexico.

        During the 80+ years that the PRI party held a monopoly of political power, it secretly funneled money to its putative “opposition.”

      2. DownSouth

        It’s probably nowhere expressed better than in the florid rhetoric of Robert Hughes:

        And it is lost because one side needs the other, so that each can inflate its agenda into a chiliastic battle for the soul of America. Radical academic and cultural conservative are now locked in a full-blown, mutually sustaining folie à deux, and the only person each dislikes more than the other is the one who tells both to lighten up. Such is the latest mutation of America’s Puritan heritage.

        If the American left is to vitalize itself, it will have to relearn plain English, return to the actual and resistant world, reclaim not only the Enlightenment principles but the language of Tom Paine and Orwell for himself—and it will never do that with its present encumbrance of theory. All that preserves the illusion of radicalness in academic poststructuralism and neo-Marxism is the conservative opposition. The right needs a left: if the battlements of Western culture were not under continuous siege, what would happen to their defenders? All the cash flowing to neo-con watchdog causes from the copious coffers of the Scaife family and the Olin Corporation would dry up. (The choir of conservatives denouncing “well-subsidized left academics” as bludgers, whilst taking their own subsidies from various right-wing foundations, is truly one of the wonders of American intellectual life.) As American conservatism confronts the death of Marxist ideology, its nurturing enemy, one is irrestibly reminded of the question posed by Constantine Cavafy eight years ago:

        “What does this sudden uneasiness mean,
        and this confusion? (How grave their faces have become!)
        Why are the streets and squares rapidly emptying,
        and why is everyone going back home, so lost in thought?
        Because it is night and the barbarians have not come;
        and some men have arrived from the frontiers
        and they say that barbarians don’t exist any longer.
        And now what will become of us without barbarians?
        They were a kind of solution.”

        –Robert Hughes, Culture of Complaint: A Passionate Look into the Ailing Heart of America

  13. xav

    Ambrose Evans-Pritchard is an idiot.

    Suggesting that the Greek would be better off with their own currency is like suggesting that an American subprime borrower would be better off once the teaser rate resets. It just doesn’ta make any sense.

    I also believe that that guy should spend a little less time focusing on the EU and focus instead on the ticking bomb which is the UK, his country.

  14. MichaelC

    Volcker on prop trading in testimony:

    Every banker I speak with knows very well what “proprietary trading’ means and implies. My understanding is that only a handful of large commercial banks- maybe four or five in the United States and perhaps a couple of dozen worldwide- are now engaged in this activity in volume. In the past, they have sometimes explicitly labeled a trading affiliate or division as ‘proprietary’, with the connotation that the activity is, or should be, insulated from customer relations.

    Most of those institutions and many others are engaged in meeting customer needs to buy or sell securities: stocks or bonds, derivatives, various commodities or other investments. Those activities may involve taking temporary positions. In the process, there will be temptations to speculate by aggressive, highly remunerated traders.

    Given strong legislative direction, bank supervisors should be able to appraise the nature of those trading activities and contain excesses. An analysis of volume relative to customer relationships and of the relative volatility of gains and losses over a period of time in the ‘trading book’ should raise an examiner’s eyebrows. Persisting over time, the result should be not just raised eyebrows but substantially raised capital requirements.

    And on Comm Bank/non comm bank distinctions:

    The basic point is that there has been, and remains, a strong public interest in providing a ‘safety net” -in particular, deposit insurance and the provision of liquidity in emergencies- for commercial banks carrying out essential services. There is not, however, a similar rationale for public funds- taxpayer funds-protecting and supporting essentially proprietary and speculative activities, Hedge funds, private equity funds, and TRADING activities unrelated to customer needs and continuing banking relationships should stand on their own, without the subsidies implied by public support for depository institutions.

    Those quintessetial capital markets activities have become part of the natural realm of investment banks.

    He concludes with:
    What we can do, what we should do, is to recognize that curbing the proprietary interests of commercial banks is in the interest of fair and open competition as well as protecting the provision of essential financial services. Recurrent pressures, volatility and uncertainties are inherent in our market-oriented, profit seeking financial system.

    By appropriately defining the business of commercial banks, and by providing for the complementary resolution authority to deal with an impending failure of very large capital market institutions, we can go a long way toward promoting the combination of competition, innovation, and underlying stability that we seek

    There’s more, but it sounds like he gets it.

    Note he’s introduced a new category of financial institution-, large capital market instituions which I believe includes investment banks (operating” under the cloak of a banking license”) , and “systemically significant” non-bank financial institutions.

    It may be dead on arrival given the politics, but he seems to have addressed many of the concerns you’ve raised recently.

    1. Yves Smith Post author


      While he does address in his testimony what he thinks the definition of prop versus customer trading should be, the pronouncements thus far have been that the distinction is going to be whether a trade is a customer trade versus a prop trade. So there is a disconnect between Volcker’s testimony and everything said to date. We will see soon which governs.

      Perhaps more important, because the Obama administration announced this move unilaterally, it can only apply it to vehicles subject to US banking and securities licenses. And Volcker keeps speaking of the legislation (at the very top) as applying to “commercial banks”.

      So what do you do if Goldman and Morgan Stanley give up their banking licenses, and BofA spins out Merrill? They will all maintain (Goldman most assuredly does) “oh, we don’t need those backstops, we operate our business prudently…..”?

      Moreover, did you see the list of products Volcker considered to be permissible products for a commericial banks, at the end of his testimony? It’s out of date even by the standards of 1985. No interest rate swaps. No currency swaps. No credit default swaps (yes I hate them, and they are not being dealt with adequately, but they are where price discovery takes place for corporate bonds). You can’t underwrite and trade corporate bonds without being in CDS.

      So the groundwork is already in his speech for the industry to make objections which will allow the proposal to be gutted. What happens if an investment bank gives up its banking license? What happens if banks can shift risk books (and various types of prop trading) to offshore vehicles? The US can’t euthanize Citi thanks to its foreign deposits, and the investment banks are likely to continue to be equally difficult to resolve. As long as we still have a repo and a CDS market, they banks will be enmeshed, and bringing down one will jeopardize the entire system. I’m sure the investment banks would be able to figure out a way to shift risk out of the jurisdictional reach of the Fed and SEC. Lehman had over 100 legal entities when it went bankupt.

      1. Siggy

        Prop trading is very hard to define. It’s not like porno and you might not recognize it when you see it. Siggy’s Rule, don’t legislate against that which you cannot define.

        Why are we worried about prop trading? It seems that much of the trouble we are having is that parties have executed contracts that they cannot honor. Now what should happen when that occurs? The party that defaults should go to the bankruptcy court. The individual who made the trade needs to go to jail because he committed a fraud.

        The Volker Rule is an idea that needs to be discussed. In the dialogue we may get to the idea that swaps, CDOs and CDS are not essential to an effective market for the intermediation of savings. We traded bonds without them in the past and we can do that again. Price discovery is process that benefits from a central market where all the parties can see the flow of prices. Can’t do that very well in the over the counter market. Have to talk to too many people. Electronic trading helps in that it creates a virtual commitment of traders tally.

        Help me with this, why does a trader absolutely need to enter into a swap, CDO or CDS? Now when is the trader acting as agent, or principal? Would trading as agent qualify as proprietary trading; or, is proprietary trading limited to trades made as principal? Do firms sometimes trade as principal in order to hide their agent position to the benefit of their client?

        Want to recapture control of derivative trading, be very clear, there is no individual or institution that is too big to fail!

        As to President Obama, I considered him to have been a lame duck the day he was elected. In fact I have suspected that he was a lame duck the day the Democratic Party nominated him to run for the office. Further, it is my opinion that the Republican Party allowed Mr. Obama to win by offering up a weak candidate and limited support. The electorate, when polled, says it wants change. The change we have received is really quite small because like a large ocean going liner, the administartion of the Federal Government cannot and never has turned on dime. It takes time.

        Will President Obama salvage his presidency? Maybe, maybe not. Political head games and spin will not help him. More than anything the kind of change that has to occur is with respect to the enforcement of the laws that are now on the books. The pandering palaver that eminates from this administration would be laughable were the circumstances not so dire and the economy so fragile.

      2. MichaelC


        Regarding the unilateral move issue, have a read of Sorkins final report on the Davos summit. Here are the concluding paragraphs.

        And so perhaps it was surprising that by Saturday, after many of the biggest names had already flown back in their private jets (yes, many took private jets, though it is worth noting that Mr. Diamond did not, nor did George Soros nor Eric Schmidt of Google, for those of you keeping score), the beginning of an agreement started coming together.

        The credit, according to some in the room, goes to the chairman of the Financial Services Authority, Adair Turner. He suggested that there needn’t be an outright ban on proprietary trading — defined in the widest terms possible, including trades that relate to clients — but that there should be a cap on the percentage of the business that it represented. It appeared to be a fair compromise that many could agree on.

        But first, it needed someone’s blessing. A call was placed to Paul Volcker later that day, according to one participant. Now let’s hope they stick to it when the hangovers wear off.


        The earlier sections describe the bankers apoplexy (sp?) over their reaction to ‘prop trading’ definitions.

        I’ve also been reading elsewhere (sorry didn’t keep the links) that Volckers approach is not inconsistent with the basic G20 proposals so a US solution based on his principles isn’t a radical departure from the global regulatory concensus. I put the unlateral risk issue toward the bottom of the list of threats to his proposals.

        Regarding the debanking by the remaining Ibanks, Volcker’s OpEd provides some insight.

        I do not deal here with other key issues of structural reform. Surely, effective arrangements for clearing and settlement and other restrictions in the now enormous market for derivatives should be agreed to as part of the present reform program. So should the need for a designated agency — preferably the Federal Reserve — charged with reviewing and appraising market developments, identifying sources of weakness and recommending action to deal with the emerging problems. Those and other matters are part of the administration’s program and now under international consideration.

        As you see, he’s not ignoring the issue, rather his view is that other parts of the reform legislation will address those issues. Specifically, Reed/Gregs House legislation on derivatives and credit rating agencies reform and Warner/ Corkers work on systemic risk and resolution authority and Dodd/Shelbys work on the super regulator.

        The Ibanks, if they debank, won’t be unregulated. They’d fall under the purview of the super-regulator I think.

        I agree with your conclusion that there is room for the industry to make mischief and gut the reforms through political maneuvers. But I’m not as sanguine as you seem to be that it’s a foregone conclusion they will be gutted.

        The political machinations are beyond my comprehension so I defer to the wisdom of others on that score.

        I’m not sure what to make of the product list. It does seem to be incomplete

    2. DownSouth

      Volcker: “By appropriately defining the business of commercial banks, and by providing for the complementary resolution authority to deal with an impending failure of very large capital market institutions, we can go a long way toward promoting the combination of competition, innovation, and underlying stability that we seek”
      Michael C: “There’s more, but it sounds like he gets it.”

      Does he get it?

      What I take this to mean is that Volker wants to rope off commercial banks (depository institutions) and keep a tight leash on them.

      Then the “capital market institutions,” which I take to include broker-dealers and hedge funds, will have their little sand box in which they can do whatever they please, sans regulation. Then when they get in trouble, we will let them fail via a “resolution authority.”

      But it will never happen as Volker envisions. The broker-dealers and hedge funds have become too systematically important to let them fail. Essentially he is now living in the same “paradise of innocence” (Reinhold Niebuhr) that the libertarians and Marxists live in.

      The necessity of regulating the “capital market institutions” is every bit as great as regulating the “commercial banks.” If you wait to intervene until after they implode, it’s too late, as the damage has already been done.

  15. Sam

    When they get in the back room, Republicans and Democrats are slapping each other on the back, saying what idiots we all are. They are out to get it all, throwing us a bone or two. I would like to see these politicians sent down to Haiti to do burial detail. They could make soylent green out of what they find laying around and send it back to their families state side.

  16. Hugh

    “by providing for the complementary resolution authority to deal with an impending failure of very large capital market institutions”

    This seems like wishful thinking to me on many levels.

  17. Francois T

    A proposal by former Federal Reserve Chairman Paul Volcker to limit bank’s proprietary trading will be either be dropped or significantly modified in the Senate…

    Boy! Do I feel to engage in fine analytical subtleties here?

    Nah…not really!

    As noted by Frank Rich, the Senate has been incapable of tackling any important national problem for 4 decades now. Be it infrastructure, energy policy, education, sensible financial regulation, health care reform, farm subsidies, constant bloating of the military-industrial complex…you name it, they can’t do it!

    Which begs the obvious question:

    Who needs the terrorists, when this country already has the biggest obstacle to any meaningful and needed progress for almost half a century?

    Et Vlan!!

  18. Paul Tioxon


    I am not sure if I should take a pledge against what has been pointed out to me is an obscenity. Just so you know, I did not offer the term “Tea Bag”, I am only reporting the facts as I hear them, from the people themselves that identify with the Boston Tea Party. The above link is to some such groups and as you see, it is what they call themselves. It is also reported in other media, including NPR, who are the touchiest of liberals when it comes to untoward and forward behavior in relation to diction. So, unfortunately for some, I have made it a point to read the best economic blog on the web, when it ventures into the political part of the political economy. I find the site can provide a thin gruel when it comes to the political realities of America, but I believe in sharing and learning from those I share with. If anyone is offended by the use of tea bag, please contact the groups who have started to call themselves by these terms, and let them know that you wish they would style themselves after something more palatable to your uptight middle class plastic pose, may I suggest the know nothing party as a good start.

  19. fajensen

    how is he going to react to the near certainty of being stymied on the domestic front?

    I believe that the man is simply a narcissist. Therefore he will react in one of the following ways:

    With a fit of narcissistic rage, this will be fun if he does it on TV, less fun if he attacks Iran to show the world he is not the pussy everyone knows he is (and to be better than Bush).

    With withdrawal, Obama will spend a lot of time doing things that attracts the cheering crowds but produces no results and therefore aways “succeeds”, i.e. rebuilding his bruised self-image.

  20. Thomas Barton, JD

    I think Republican intransigence is overstated as an effective blocking mechanism..Calculated Risk blog sees an avalanche of foreclosures in the next 8 months..This will put enormous pressure on new candidates running for office. The Massachusetts story is also one of Republican weakness in the field of battle so to say. Mr. Brown rarely identified himself as a Republican..Also the Republican Money Machine of the past several election cycles has collapsed..It is far behind the anemic performance of a disenchanted Democratic operation. Shelby will undoubtedly become a resignee as has Dodd I believe. Events can overwhelm mice and men and the combination of CRE accelerating losses and foreclosures will put a whole different spin on discourse in September and October. Remember in 1962 that the Soviets had begun preliminary groundwork in Cuba and the CIA tracked it until the official history says that in August the President became involved..September and October marked an exceedingly rapid escalation of activity.. The Republicans have very little money now and appear unable to do much better in the fall.

  21. Maggie Knowles

    Bipartisanship is the strategy used by the Obama Administration to give their support of corporate interests and to excuse their lack of support to the good people who elected the president. It’s working REALLY WELL for them. Brilliant!

  22. dilbert dogbert

    We have no net gain from 10 years of investing. The question I have for all you smart people is: What the hell does one do if Obama is a lame duck and the Republicans regain the Senate?
    A return to Republican control of all 3 branches of government scares the hell out of me. I am not sure we can survive another 8 years of Republican economic policy, foreign policy and domestic social policy.

  23. bena gyerek

    “Will he seek to compensation by devoting more effort to foreign policy? Given his surprising and troubling surge strategy in Afghanistan, I’m not sure I like the possibility that Obama will try to score policy victories, and perhaps literal victories, abroad.”

    In a word, China.

  24. Percy

    I do not see what’s wrong with what Volker proposes if “customer trade” is construed to mean with the banking entity acting as agent for the customer and “principal trade” to mean for the banking entity’s own account. Volker seems to imagine, however, that there is a need for banking entities to sometimes temporarily take principal positions for customers. I would reject that as a very bad idea if one is going to go this route at all. I do not see anything important added by saying that this applies to derivatives, too, broadly defined to include swaps. No exceptions — except perhaps for Treasuries and state and local government obligations, something one could do without breaking all the China. Yes, it would rip apart trading practices that have grown up in the last part of the last century and since, but so what? Does that mean that no bank could deal in FX? No. FX derivatives? Yes(since they are not issued by goverments). Just deal with the idea that a risk is being assumed. Was this not general practice once upon a time? Admittedly none of this may be politically acceptable to Republicans, but they, too, have to keep an eye on an aroused public, one mad as hell about the banks. I do not agree with the notion that broker-dealers and hedge funds have in some cases become TBTF. If the world’s large banks and national credit have been insulated from them by this means, who cares about them? Because they are and stil will be so intertwined with each other and the wreck, if one occurs, will be big and international LTCM comes to mind)? Much of that can be solved by controlling leverage and putting in more sensible capital requirements internationally, can it not? That’s a collateral regulatory issue once the business has been taken away from commercial banking entities — and the broker-dealers and hedge funds will surely be regulated everywhere to a far greater degree than is the case now. Having done all that, the banking system can keep the taxpayer back-up and the others left to their own devices.

  25. Tall Paul's id

    Mister President, this banking business is a nonproblem. You have emergency dictatorial superpowers and a cretinous populace. Just draw up any regs you want in secret and leave yourself a day or so to implement it with the following foolproof method: Shriek up some jingoistic hysteria about a national security emergency. Then invoke P.L. 81-774 to impose sectoral regulations by fiat (and don’t give me this it can’t be done; just use some of the geniuses who figured out how to let Yoo off for war crimes.) Then bask in the popular adulation. Maybe dress up in a flight suit and caper around on a carrier.

  26. scharfy

    Obama, if he’s not already a lame duck, seems to be growing webbed feet at an alarming rate.

    He needs to remind us stupid Americans of his greatness, of why we elected him.

    Its a recession, so what people really want are many awesome speeches, loaded with gushy platitudes, to make them feel better. This will make us think it is 2008, and we will love him again.

    We as Americans have short memories, so chapters 1 and 2 of “The Audacity of Hope” would probably seem new to us.

    Supermajority in tact, and public mandate in pocket, the ensuing democratic legislation should ensure American prosperity for the next millennia, as long as dumb republicans don’t screw it up.

    But he’s gotta look himself in the mirror, find the inner O, and remember that it was the rousing sermons that changed the world.

  27. radicalized

    I am glad to see you are finally comimg around Yves.
    Here is my post o 1/23/2010

    Maybe I missed it, but I have never seen any discussion on this blog about Ron Paul. How many times are we going to see “Tall Paul is my hero” as if Volcker would reform the Fed. Granted he is making noises about some separation between banking and investment banking. So what. Any bill passed by Congress along those lines will be so watered down that we will get only the appearance of regulatory reform, while the bankers will probably have their control of the economy enhanced.

    To be perfectly clear, I don’t entirely trust Ron Paul either, but who else in Congress is for getting rid of the Fed entirely. A new Fed chairman wont solve the problem, no Fed will.

    Me, again. Yves, when are you going to do a post on Ron Paul?

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