Big Wall Street Firms Make Lame Excuse for Volcker Rule Non-Compliance, Ask for Additional Five Year Extension

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.”


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  1. vlade

    Basically they want to wait until it rolls off by the sound of it (at least some).

    Over a period of a few months, liquidity exists for everything – if the price is right for the preceived risk. Real lack of liquidity happens only when there’s a very short timeframe shock with no-one having an idea of the final impact (say when Swiss dropped the floor, the liquidity in the currency and derivatives was nil for a few hours. There was literally no-one willing to sell CHF for about two hours or so, more for derivatives). But it came back even by the end of the day. Even for stuff like exotics CDOs there was some liquidity at rock-bottom price.

    What I’m curious about is how the new Market Risk rules will be implemented/postponed. Their implementation is tricky in itself and their consequences can be deadly for more complex products (feature, not a bug). At the moment it seems to me there’s quite a bit of complacency (relatively speaking) in the industry – I guess similar to Brexit (when you close your eyes and can’t see the problems, they cease to exist).

  2. Jim A

    “Price it well, it will sell. Price too high, wait and sigh.”

    Can they present any evidence that they HAVE been selling these assets? Because if the demand is limited and inelastic sometimes it DOES make sense to spread things out. But if they haven’t been selling ~20% of these assets per year than they just don’t like the current prices for any volume that they put on the market.

    1. Jim A.

      To expand on this a bit. To a very real degree, the reason for banks to exist is duration mismatch. They can aggregate a large number of deposits and then loan the money out for longer terms. Occasionally a large number of people want their money out and the bank only has loans. That is the reason for the Bagehot rule. The money that you funnel to the banks to avert a run is supposed to be based on GOOD collateral. To a real degree, deposit insurance is a promise to support banks before there is even a hint of a bank run. In exchange we have bank examiners pre-rating the securities held by the bank. It is okay if they are illiquid if they are VERY SECURE, in the way that mortgages were once believe to be. But to have an asset that is both difficult to value/or has a very variable value AND is illiquid is to not have that asset, even as security for a loan when you really need it.

      1. Phil

        Money exists as the answer for “duration mismatch.” Let’s revisit the definition of money, “a store of wealth and a medium of exchange.” Yup…that sure works great for something like “duration mismatch.” Banks theoretically exists for the sole purpose of pricing loan risk–specifically by issuing loans. Thinking fo them as some benevolent entity in the marketplace is exactly the thinking that caused regulators to fall asleep at the wheel and miss extreme risk-taking positions while under the auspices of FDIC protection…And, your reversed assets and liabilities. Assets have value even if nobody believes they do. Debts on the other hand are destroyed if nobody believes they will be repaid. Assets require the actions of no counter party, yet liabilities always have a counterparty. If assets do have a counter party, they are probably not “real” assets…aka mortgages on a bank’s balance sheet listed as “assets” can very well be a dubious label…

  3. ArkansasAngie

    Mark to Market?
    This has never been about liquidity. It’s always been about avoiding insolvency.
    Greater good? Nope.

    Price discovery? Obviously the emperor has no clothes.

    But hey! Look over there … it’s a … it’s a … Trump.

    A vote for Gary is a vote for HRC?
    A vote for Jill is a vote for Trump.?

    Horse manure.

  4. Otis B Driftwood

    But … but … but … Janet Yellen is/was one of the good guys. Isn’t/Wasn’t she?

    Who was it that said “personnel is policy”?

    … sigh

  5. jawbone

    Well, maybe Goldman’s “exposure” is why they so generously compensated Hillary for her speeches.

    Goldman seems very astute about planning for future political assistance….

    1. Jim Haygood

      Goldman should hive off a “bad bank” to shed its illiquid sludge at a deliberate pace.

      And put Clinton in charge of it. Now her speech fee becomes “buy $600K of dodgy assets for only $300K … such a deal! Would I lie to you?” etc etc

  6. Peter Pan

    If major Wall Street firms are asking the Fed to delay Volcker Rule implementation, I wonder if these firms are hoping that increased lobbying will help introduce legislation to eliminate some or all of the Volcker Rule with a new 2017 legislature and administration?

    Also, could some of these illiquid positions be a part of the reason that the Fed is rejecting these firm’s “living wills” for an orderly resolution to their operations as required by Dodd-Frank?

    1. Jim A

      5 year extension makes me believe that they think that even a likely Clinton presidency will be insufficiently subservient to them and they’re already pinning their hopes on a Romney-like candidate in 2020.

  7. Paul Art

    On another note, Shillary issued an ‘economic plan’ in response to the Trumponomics speech recently and one of the points is ‘Reform Social Security’. Wonder what this is. Could be the final Cat Food giveaway to Wall Street.

  8. JimTan

    The Volcker Rule exempts ‘hedging’ activities from its proprietary trading prohibition. Interestingly, this exemption is written as a comprehensive definition of – in it’s own words “permitted risk-mitigating hedging activities”. Qualifying for the exemption requires extensive reporting of hedges, and regulatory compliance with hedging rules. What this means is any bank that classifies transactions in derivatives collateralized by federally insured deposits as ‘hedges’ must provide more proof these are true ‘hedges’ and not ‘speculation’. If they are ‘speculative’, then they must be sold or comply with Basel risk weighted assets (RWA) calculations. This is essentially the type of thing that went on with JP Morgan’s London Whale fiasco. In their case massive losses were triggered when new Basel III Rules required them to sell CDS speculative positions previously designated as deposit ‘hedges’. I suspect this may be one reason for postponing adoption of the Volcker Rule.

  9. griffen

    Rules are for the suckers. But riddle me this, can a $10 billion bank request the same breaks (forebearance, and so on) and bend the ears of the Fed ? One thinks…nope.

    Its no wonder community bankers are increasingly angered at this nonsense.

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