Because it’s become so routine, it’s hard to get outraged about brazen behavior by the Wall Street heavyweights, but this incident is a noteworthy exception. Major Wall Street firms are asking a clearly-in-the-tank-for-them Fed to delay Volcker Rule implementation an astonishing additional five years. And what’s the excuse? That they have some “illiquid” positions that they need more time to sell. This is after implementation of the Volcker Rule having first been pushed back by four years and the banks having obtained an additional three years of extensions.
Anyone who knows bupkis about finance knows if you can’t sell a financial asset in three years (or more accurately, seven), particularly with public and private market valuations at record levels, the problem is not liquidity. It’s valuation. These banks are carrying these holdings on their books at inflated marks and don’t want to recognize losses.
As we discuss below, the Fed has repeatedly behaved in an intransigent manner regarding the Volcker Rule, effectively thumbing its nose at Congress. As we reported in the runup to the crisis, it behaved the same way with the Home Ownership and Equity Protection Act, which was meant to limit abuses with high interest rate mortgage loans, particularly refinances and home equity loans. As we wrote at the time, Fed officials dismissed the notion that homeowners ever could be the victims of bank abuses. Any fraud was borrower fraud. By contrast, even the famously bank cronyistic Office of the Comptroller of the Currency took HOEPA enforcement far more seriously. So the Fed’s defiance of the will of Congress has played a direct role in contributing to systemic risk,. The central bank again seems determined to shelter banks rather than do its job.
The idea of a five-year extension seems to be far outside the Fed’s authority under the Volcker Rule. If this does happen, it will rely at best on a strained interpretation, which really boils down to force majeure: who will stop the Fed if it ignores the law and comes up with a shabby pretext?
Members of Congress and the public should demand that the banks write down these supposedly illiquid positions to zero if they cannot unload them at the end of their current extension period. It’s not hard to imagine that forcing these firms to recognize the losses would lead them to accept realistic prices and thus find buyers.
Now for the details.
In an exclusive story, Reuters reports that Goldman Morgan Stanley, JPMorgan and other unnamed banks are pressing the Fed to obtain a five-year extension on Volcker Rule compliance to give them more time to exit holdings that are no longer permitted under the Volcker Rule. We wrote extensively about the Volcker Rule when it was under debate. While its intention, of restricting the use of government guaranteed deposits to fund speculation, we thought Volcker erred in trying to draw a line between “customer” trading and proprietary trading, since taking the other side of a large customer position is often speculative and it may take some time to exit that holding. We thought a better distinction was to look at risk levels, since trading-desk risk assumption would be a better measure of wagering, as opposed to facilitating customer orders. And ironically, risk and compliance experts said that the generally-derided Value at Risk model, which proved to do a poor job of capturing exposure to “blow up the bank” events, was well-suited to capturing this sort of shorter-term exposure.
But putting that issue aside, the industry has had ample warning as to what was in store. The Volcker Rule was set to go live in July 2010, but various rearguard actions resulted in the final version of the rule becoming effective only as of April 1, 2014, with banks astonishingly getting an additional gimmie of not being required to “conform their activities” prior to July 21, 2015.
Note that the Reuters reporting is misleading in underplaying the degree to which the Fed is defying Congress on implementing the Volcker Rule. It blandly reports that the bank have already received three one year extensions. It fails to mention the initial delaying action, and also omits the way the Fed poked Congress in the eye with how it handled those “three one year extensions.” The first was presumably the nearly 15 month compliance delay. But as we described in an early 2014 post, the Fed rolled that into a second delay:
…the Fed almost immediately on the heels of the Congressional defeat on the swaps push out delayed Volcker Rule implementation by an additional two years. And this was clearly [general counsel Scott] Alvarez’s doing, since the finesse to do what comes uncomfortably close to violating the statue has to have issued from his office. From Dayen:
To accomplish the latest two-year delay, the Fed had to break the spirit of the rules. The Fed is empowered under Dodd-Frank to delay regulations like the Volcker rule for only one year at a time. So in its announcement, the Fed both acted on a one-year delay to 2016, and also “announced its intention to act next year” on “an additional one-year extension.” It did not require banks to apply for the extension based on objective information about particular hard-to-unwind investments.
Get that? The Fed announced now that it plans to punt on implementation next year. Cute.
The Reuters story does state that the banks got their third one-year extension last month.
We explained further in the same post how gutting Dodd Frank preserves the Greenspan put and undermines monetary policy. So Scott Alvarez’s actions impinge on Fed decisions that appear unrelated to his official purview.
And in 2015, Warren demanded an explanation from Janet Yellen over Alvarez’s blowing off a request to brief Warren and Elijah Cummings on an apparent Fed failure to investigate a leak of FOMC information that moved markets as well as Alvarez dissing key sections of Dodd Frank at an American Bankers Association conference. Yellen played contrite at the Senate hearing and then defied Warren by issuing a statement backing Alvarez.
Reuters also indicates that Goldman is most exposed and has a hard time credibly claiming it can’t get out of these positions, since it previously told shareholders it could:
As of June 30, Goldman Sachs held $7 billion worth of private equity investments, real estate holdings and hedge funds affected by the Volcker rule. In March, Goldman said it expected to sell the majority of those stakes before the July 2017 deadline, but it removed that language in its most recent quarterly filing.
Morgan Stanley, which has about $3.2 billion in real estate and private equity funds, recently said it expected to be able to divest much of those investments. But the bank said in a second-quarter filing that it expected to ask for further extensions “for certain illiquid funds.”
JPMorgan has around $1 billion in hedge funds, private equity and real estate investments.
The banks and Fed need to be called out on this nonsense. From the Reuters story:
“It’s laughable that the biggest, most sophisticated financial firms in the world claim they can’t sell the stakes year after year,” said Dennis Kelleher, CEO of non-profit Better Markets. “Everyone else in America has to comply with the law and Wall Street should also.”