The Volcker Rule:Proprietary Trading

One of the many problems on Wall Street and Institutional Financing worldwide is the Proprietary Trading by banks and other financial institutions. This is where they use portions[sometimes dangerously large portions] of depositor/clients cash to enable themselves totrade in potentially highly lucrative own account positions in the volatile and risky derivative and other shadow markets. They make billions per quarter on these trades but they have a number of problems:
1)those markets are shadow and complex  with only a few parties knowing who has what exposure  given that second derivative  and tranches [splits of contracts] can be transacted. So who owes what and when if something goes belly up is hard to trace. This is Lehman and AIG squared and  Financial Meltdown symptom No 1 – lack of transparency and efficient/sufficient information  available to all parties involved in the complex derivatives/shadow markets  world.
2)those markets are effectively closed but to a small group of traders – not coincidentally, the select Too Big To Fail financial institutions. Financial Meltdown symptom No 2 – closed shadow markets  with dominating positions by self-selecting Too Big To Fail financial institutions.
3)those market trades open the TBTF-Too Big To Fail financial institutions to many potential conflict of interest positions as when Goldman Sachs made the market for mortgage  CDS and then in their proprietary account bet against their clients. Financial Meltdown symptom No 3 – fiduciary trust declines to zero sum while conflicts of interest multiply exponentially.
4)those markets currently are unregulated and the source of great systemic risk. But TBTF fiancial institutions are lobbying fiercely against any  controls whatsoever. Financial Meltdown symptom No 4 – the financial system is simply a)not subject to market discipline [TooBigTooFail and engaging in flawed/deficient shadow markets] and b)are simply not learning as in the progression of S&L Failures with mop up by Resolution Trust begets LongTerm Capital Management begets DOT.Bust begets Financial Meltdown 2007-2009 attests to.
So given this backdrop, Former Fed Chairman Paul Volcker [Financial economic rescuer of during the Reagan hyperinflation era]caught everybody’s attention when he proposed and got President Obama to accept having no more proprietary trading by banks as a critical component for financial regulation.


That hit like a brickbat straight to the gut on Wall Street. Suddenly the Street was paying direct rather than K-Street attention to what was happening in financial regulations. So it is interesting now that Barclays Bank in England which has made a record shattering $18B fourth quarter profits propelled on by principally by proprietary trading, the financial lobby is out saying we told you so.
24/7 Wall Street is typical. I am paraphrasing. “Look the Brits can do it. So as we told you if you regulate us with no proprietary trading, business will be lost to London and other financial markets. And if you want healthy banks in the US you cant take away their cash cow – proprietary own account trading – conflict of interest and fiduciary trust be damned[oops, not stated but obviously implied].”
Lost in the shuffle was the following remarks:

Proprietary trading may be a danger to bank balance sheets. Volcker and others appropriately worry that banks which hold customer assets should not leverage those assets to make trades which carry great reward but also great risk. Volcker would severely limit or eliminate this sort or risk.

But, multinational banks cannot afford to lose their proprietary profits. Volcker and his supports may have to make a compromise so that bank shareholders do not see earnings evaporate. The solution may be as simple as setting up an FDIC-like fund to cover trading losses. The cost of the “insurance” for large banks to cover potential trading losses could be in the billions of dollars each year. But, that is probably better for them than the death of their most profitable businesses.

What is very interesting about these remarks by 24/7 – is a)they are 24/7’s not the TBFT banks, financial institutions or their proxies so readers have no inkling of their support on the broader Street; b)they do acknowledge many of the points made above and underline that Volcker has legitimate causes for concern; c)they are the first time I have seen even a member of the Street Press corps acknowledging that banks do have to pay billions for insurance against risks they are engendering and d)look what supposed free, efficient financial markets are relying on – governments to create the markets for systemic insurance because by gosh the TBFTs have failed to self regulate and/or create such markets effectively in say the past 20 years[okay 200 years]. So all you Ayn Randers – take note – the biggest and the best financial institutions just can’t and won’t manage risk on their own as Greed and Zerosum trumps co-operation and even survival.

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