Defanging Already Weak Financial Regulation
I sure hope somebody is going to notice the fine piece on the front page of Thursday’s New York Times about how easy it is to get around the Volcker rule. Remember how the Obama team that came up with its reregulation proposals seemed to push Paul Volcker aside? The former Federal Reserve chairman was supposed to be running a committee on the subject for the president, but even he let it be known no one was talking to him much. Volcker was concerned that commercial banks were using insured depositor money to make risky investments and to drive huge bonuses — and the Fed and the FDIC would be left picking up the pieces. The system should not be bearing that much risk, he wisely figured. And to be fair, he had long felt this way.
After an earlier front page Times piece by Lou Uchitelle on Volcker’s concerns, Obama suddenly embraced a limitation on such trading — the Volcker rule. There were many Volcker photo ops. There would now be a ceiling on what trading could be done for the banks’ proprietary accounts — its own assets. The Dodd-Frank bill embraced the idea. Problem solved.
No way, of course. The trouble is, banks have been trading for their own accounts to one degree or other for decades while making markets for their customers. In the late 1970s and early 1980s in particular, they first discovered they could generate big profits if they bought extra securities (or derivatives) at propitious times under the guise of keeping inventory to facilitate trades of their investors and corporate clients. They could also hedge their positions by selling. In truth, it wasn’t even a disguise. They gambled money, but like all market makers, they had an insider’s edge. And they made fortunes. Some of the investment bankers, in particular, loved the traders who took the big risks.
Of course, occasionally, they lost big — and some of the losers made headlines. But mostly they made out like bandits. Over time, the lucrative practice was moved to the “proprietary” desks. That’s where Howie Hubler lost $9 billion in a mammoth mortgage transaction for Morgan Stanley, as reported by Michael Lewis in The Big Short. I was never clear why the press didn’t make more of that after Lewis divulged the unpublicized catastrophe. No one ever lost that much money on a trading desk before. Once not long ago, if you lost $200 million it was a scandal.
Now Nelson Schwartz and Erich Dash have put their finger on what seemed to be hidden from view. The banks do a lot of this all the time, and they are doing it big-time again, the reporters found out. As they quote one consultant, “You can use client activity as a cover for basically anything you are doing.” And the fact is that they do, and have done so for a long time. As the Times reporters write, “For all the talk of shutting down trading desks and reassigning employees to prepare for the Volcker Rule, proprietary-style trading will probably survive, if under a different name.”
So much for the Volcker rule. And the great man himself (that is, Volcker) never came to grips with this immense hole in the regulations, either. High risk on Wall Street will go on.
Meantime, Sheila Bair found it necessary to argue in this week’s Financial Times that stronger capital requirements will make the financial system better — that is, help allocate capital where it is actually needed and useful. She apparently feels she has to defend higher capital requirements against influential complaints coming from the powerful financial community that they will undermine lending and raise interest rates. Yes, and regulations to limit oil spills will raise gas prices, higher wages will undermine corporate profitability and capital investment, and product safety standards will limit the number of toys parents can buy for their kids. Industry goes on and on. As if, suggests Bair, the earlier inadequate capital requirements resulted in no financial or social cost. Consider the credit crisis and the recessionary aftermath.
The financial reregulation package was never strong enough, but the battle to make work even what was passed, will go on. Nothing is quite so irksome as the financial community talking about how little TARP cost taxpayers as banks paid back their bailouts. First, TARP should probably have made money, like Warren Buffett will on the money he lent Wall Street. But second, the big cost is severe and ongoing recession resulting in hundreds of billions of dollars of lower federal tax revenues for years, unemployment rates near ten percent, and weak capital spending. Let’s keep straight how much financial excess has and will continue to cost America.