The goal of financial reform is simple: to protect taxpayers, our treasury and our economy from suffering a repeat of the 2008 collapse by making our financial system safer, sounder and more stable. The cornerstone of financial reform is the law known as Dodd/Frank, designed to make our financial system less prone to crisis, failure and bailout.
One of the rules at the heart of the law is called the Volcker Rule, a long and complex rule named after former Federal Reserve Chairman Paul Volcker that embodies a very simple idea: the very few biggest banks in the country should not be able to make risky bets with borrowed money and count on taxpayers to bail them out if those bets go bad. Commercial banks are supposed to be banks -- not hedge funds, not derivatives traders, and certainly not government-backed gamblers.
The Volcker Rule bans what's known as "proprietary trading," but only at the very biggest banks. A fancy term, but proprietary trading just refers to trades made by banks with their own money as opposed to a customer's money. So if it's the bank's money, what's the problem? The problem is that proprietary trading usually involves very big bets made with borrowed money, and if a big bet goes bad, then the public's money and the treasury's money are at risk as well. That's because the biggest banks won't be allowed to fail so when the bets go bad taxpayer-funded federal support ends up paying off the bad bets.
The biggest banks and their mouthpieces want everyone to forget that very big, very bad proprietary bets were at the heart of the near collapse of worldwide financial markets in 2008. Take Citigroup. It lost almost $40 billion through just one type of trade and tens of billions more on other bad bets, forcing the U.S. government to bail it out with more than $45 billion. The same was true for every major bank in 2008: reckless trading put them at the edge of bankruptcy and the only reason they all didn't go bankrupt is because the federal government bailed them out with taxpayer money to save our economy from collapsing into a second Great Depression. Those banks also want everyone to forget that those Wall Street bailouts cost the US many trillions of dollars and gave us the worst economy since the Great Depression.
No matter how many times the banks and their purchased allies shout it, the Volcker Rule doesn't ban risky bets. If anyone wants to make a big bet on European debt or swing for the fences on some other risky trade, then all they have to do is go to a hedge fund or any one of hundreds if not thousands of other financial firms that aren't too-big-to-fail and therefore don't risk taxpayer money That's what happened to MF Global: it made big proprietary bets with borrowed money; those bets lost; and, it went bankrupt as companies are supposed to do when that happens.
The Volcker Rule just says the biggest too-big-to-fail banks, those that receive federal support and are actually guaranteed federal support by law or practice, are different than other financial firms, so they should be treated differently. Those guarantees -- which protect your deposits and give banks access to money at very low interest rates through the Federal Reserve's discount window -- are designed to protect customers' savings, promote loans to businesses and households that help fuel economic growth, and make sure our financial system doesn't collapse. They aren't designed to provide a safety net for megabanks and their traders making mega-bets to boost their profits and bonuses. But without the Volcker Rule, that's exactly what did happen and what will happen again.
Of course, the megabanks love proprietary trading. Why? Because when they win their bets, they make more money and their bankers take home literally billions in bonuses. And when they lose, somebody else has to pay the bill.
This is make or break time for the Volcker Rule. The public comment period ends today, regulators are finalizing crucial details of how the Volcker Rule will be implemented. Not surprisingly, Wall Street and its army of lobbyists are spending millions in an all-out effort to create giant loopholes in the rule.
The banks throw around terms like "market making," "portfolio risk hedging," and "client trading" to suggest that they are really only acting in their customers' interest. And they claim no one can really tell what proprietary trading is anyway. But former Federal Reserve Chairman Paul Volcker, the architect and namesake of the rule, has said "every banker I speak with knows very well" what is a risky trade that benefits the bank, rather than the customer.
The argument for the Volcker Rule is obvious -- we shouldn't allow risky bets that pay enormous bonuses to bankers if they work, but stick taxpayers with the bill if they fail. That's not capitalism; that's basically a subsidized trip to the blackjack tables. Anyone can go to Vegas, but the taxpayers shouldn't pay for the trip and all the losses.
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