Volcker On Volcker Rule: Make It Airtight
Paul Volcker, the former Federal Reserve chairman, wants the rule that bears his name to be as airtight as possible, the Wall Street Journal reports.
The so-called Volcker Rule, which appears in July's Dodd-Frank financial reform, and which Volcker helped create, has yet to be fleshed out. It limits taxpayer-backed banks' ability to make trades with their own money, behavior that earned banks big profits but also saddled them with big risks in the years leading up to the financial crisis. As the details of the relevant rules will be written next year, Volcker, the WSJ says, wants to leave no room for ambiguity: Proprietary trading should be banned at any bank that enjoys a government guarantee.
In its outlined form in the Dodd-Frank legislation, the rule is weaker than Volcker, who chairs the president's Economic Recovery Advisory Board, had hoped. As he conceived it, it would have banned entirely banks' practice of trading for their own account. But in its final version, it allows banks to invest up to three percent of their own capital in private equity or hedge funds. As The New Yorker's John Cassidy reported, the change left Volcker, to use his word, "disappointed."
In a speech last month, Volcker called the financial system "broken" and called for "structural changes in markets and market regulation."
Even though the rule hasn't taken effect yet, and even though, in its current form, it doesn't ban prop trading outright, some banks have, they say, responded by trimming or cutting their prop trading units. Goldman Sachs and JPMorgan are apparently eliminating prop trading entirely, and Bank of America is paring down its prop trading operations.
But as Michael Lewis, author of "The Big Short" and "Moneyball," wrote last month in his Bloomberg column, the disappearing prop traders are cause for suspicion -- they aren't, after all, required by law to shut down. So why, Lewis asks, are banks ducking this opportunity for profit?
He offers an answer to that question in his most recent column, in which he says that banks aren't actually cutting prop trading at all. They're just disguising it, by calling it something else. It will continue, Lewis says, because of a phrase in Dodd-Frank, which says banks can't make prop trades "as a principal." As long as banks can claim to be making a trade on behalf of a customer, they can engage in what otherwise would be considered proprietary trading.
"There are a hundred different ways to claim to be acting as an agent or for a customer," said a former Lehman Brothers salesman, whom Lewis quotes in his column.
The prop traders who have left banks have found other lucrative opportunities. Many are moving to hedge funds, which can make investments without worrying about bank-y concerns like what is allowed as "market-making" and what "conflict of interest" means.
Loading comments… 
The Huffington Post William Alden First Posted: 10/29/10 10:16 AM ET Updated: 05/25/11 07:10 PM ET