"The Volcker Rule - The Marshall Comes to Dodge"
Sydney M. Williams
No one should be surprised that removing the cookie jar creates tears. But the tantrum being thrown by those model citizens at Goldman Sachs, as plans are being finalized for the implementation of the Volcker Rule, is unbecoming even to the rough and tumble world of Wall Street. The firm has outspent its competitors, by a wide margin, in an attempt to influence the implementation of the Volcker rule. As one lobbyist put it, “They’re totally freaked out about Volcker.”
Paul Volker, former Chairman of the Federal Reserve who slew inflation in the early 1980s, was appointed Chairman of the President’s Economic Recovery Board on February 6, 2009. A year later the Volcker Rule was enunciated. It would prohibit a bank or institution that owns a bank from engaging in proprietary trading that isn’t at the behest of its clients; it would prevent banks from owning or investing in a hedge or private equity fund; and it would limit the liabilities that the largest banks could hold. In the intervening months, in response to lobbyists, Congress and regulators have added amendments that have weakened the proposed rules.
There are five different regulatory bodies (including the Federal Reserve and the S.E.C.) now in the process of writing separate versions of the Volcker Rule. According to Reuters, under the terms of last year’s Dodd-Frank Bill, regulators have until July to come up with specific rules for implementing the Volcker provision. Goldman Sachs has wasted no time (and no money) to influence the rules and the manner in which they would be enforced. They have a lot riding on this issue. Last year proprietary trading contributed about $1.5 billion of their net income of $12.9 billion. In terms of margin contribution, proprietary trading is typically the highest. While Goldman and others argue that it is difficult to separate proprietary trades from customer orders, Mr. Volcker in a recent interview said: “Bankers know when they’re doing a proprietary trade, I assure you. If they don’t know, they shouldn’t be in the business.”
Proprietary trading would be permitted, but limited to Treasuries, GSEs and municipal bonds. Rules regarding derivative contracts have been tightened under Dodd-Frank. Banks like Goldman are lobbying to get currency contracts exempted from derivative regulation. Investments in hedge and private equity funds would be allowed, but limited to 3% of Tier 1 capital (the ratio of a bank’s shareholders equity capital to its risk weighted assets.) Under Basel II, a well-capitalized bank must have a Tier 1 ratio of at least 6%. (Those rules are expected to be tightened when Basel III go into effect in 2012.) The fate of principal transactions (merchant banking operations) is yet unclear.
Bank of America analyst, Guy Moszkowski, was quoted recently in the Huffington Post that Goldman continues to make principal investments (i.e., their $450 million investment in Facebook and a prospective investment in China’s Taikiki Life Insurance Company) because they don’t believe the practice violates the Volcker rule. On the other hand, regulators are conscious of the fact that Lehman Brothers’ participation in the $23.6 billion LBO of Archstone-Smith, a property group, contributed to the firm’s demise in 2007.
Certainly, there is a difference between picking off short term trades for one’s proprietary account and investing capital into fledging businesses. Nevertheless, and regardless of the Volcker rule, banks have a fiduciary responsibility to their depositors and, as managers of publically traded companies they are beholden to their shareholders. The moral hazard lessons created by the (necessary, in my opinion) bailouts in 2008 have, unfortunately, perpetuated a sense of “heads I win; tails I don’t lose.”
In my opinion, the decline in fiduciary responsibility on the part of investment banks began when former partnerships became publicly traded companies. It was aggravated with the annulment of Glass Steagall in April 1998 when Citigroup acquired Travelers (which owned Salomon Smith Barney.) These events marked a return to the risk taking on the part of banks that was more common in the 1920s. Spread banking was (and is) neither as exciting nor as profitable as trading.
Contrary to what the Goldman lobbyists would have one believe, the rules are not aimed at reducing profits at Goldman, though they may have that effect. They are designed to make banks and banking safer. If a financial institution prefers to trade for its own account, it has every right to do so; but not as a bank that has access to cheap capital via the Fed window and which holds individual deposits guaranteed by the FDIC.
Other than filling the pockets of traders and senior management, proprietary trading provides little, if any, economic value. At the same time, as we all know, it can create enormous risk – risk that when emanating from banks that are “too big to fail” is borne by taxpayers and shareholders, not by the perpetrators. There is nothing wrong with individuals, private partnerships or even public companies (when the shareholders are fully informed of the risks) from engaging in such activity; so long as their activity does not endanger our financial system. A recent poll of investors, traders and analysts showed that 54% view Goldman in a poor light, so my comments may be seeing as piling on.
Goldman Sachs, in the fall of 2008 and under duress, became a bank, able to access the Fed window. It should be subject to rules governing commercial banks. It always has the option to reconstitute itself as a partnership, or spin off its proprietary desks. But as it is, it has the best of all possible worlds. It is little wonder Goldman doesn’t want the system to change.
Thought of the Day
“The Volcker Rule – The Marshall Comes to Dodge”
May 12, 2011No one should be surprised that removing the cookie jar creates tears. But the tantrum being thrown by those model citizens at Goldman Sachs, as plans are being finalized for the implementation of the Volcker Rule, is unbecoming even to the rough and tumble world of Wall Street. The firm has outspent its competitors, by a wide margin, in an attempt to influence the implementation of the Volcker rule. As one lobbyist put it, “They’re totally freaked out about Volcker.”
Paul Volker, former Chairman of the Federal Reserve who slew inflation in the early 1980s, was appointed Chairman of the President’s Economic Recovery Board on February 6, 2009. A year later the Volcker Rule was enunciated. It would prohibit a bank or institution that owns a bank from engaging in proprietary trading that isn’t at the behest of its clients; it would prevent banks from owning or investing in a hedge or private equity fund; and it would limit the liabilities that the largest banks could hold. In the intervening months, in response to lobbyists, Congress and regulators have added amendments that have weakened the proposed rules.
There are five different regulatory bodies (including the Federal Reserve and the S.E.C.) now in the process of writing separate versions of the Volcker Rule. According to Reuters, under the terms of last year’s Dodd-Frank Bill, regulators have until July to come up with specific rules for implementing the Volcker provision. Goldman Sachs has wasted no time (and no money) to influence the rules and the manner in which they would be enforced. They have a lot riding on this issue. Last year proprietary trading contributed about $1.5 billion of their net income of $12.9 billion. In terms of margin contribution, proprietary trading is typically the highest. While Goldman and others argue that it is difficult to separate proprietary trades from customer orders, Mr. Volcker in a recent interview said: “Bankers know when they’re doing a proprietary trade, I assure you. If they don’t know, they shouldn’t be in the business.”
Proprietary trading would be permitted, but limited to Treasuries, GSEs and municipal bonds. Rules regarding derivative contracts have been tightened under Dodd-Frank. Banks like Goldman are lobbying to get currency contracts exempted from derivative regulation. Investments in hedge and private equity funds would be allowed, but limited to 3% of Tier 1 capital (the ratio of a bank’s shareholders equity capital to its risk weighted assets.) Under Basel II, a well-capitalized bank must have a Tier 1 ratio of at least 6%. (Those rules are expected to be tightened when Basel III go into effect in 2012.) The fate of principal transactions (merchant banking operations) is yet unclear.
Bank of America analyst, Guy Moszkowski, was quoted recently in the Huffington Post that Goldman continues to make principal investments (i.e., their $450 million investment in Facebook and a prospective investment in China’s Taikiki Life Insurance Company) because they don’t believe the practice violates the Volcker rule. On the other hand, regulators are conscious of the fact that Lehman Brothers’ participation in the $23.6 billion LBO of Archstone-Smith, a property group, contributed to the firm’s demise in 2007.
Certainly, there is a difference between picking off short term trades for one’s proprietary account and investing capital into fledging businesses. Nevertheless, and regardless of the Volcker rule, banks have a fiduciary responsibility to their depositors and, as managers of publically traded companies they are beholden to their shareholders. The moral hazard lessons created by the (necessary, in my opinion) bailouts in 2008 have, unfortunately, perpetuated a sense of “heads I win; tails I don’t lose.”
In my opinion, the decline in fiduciary responsibility on the part of investment banks began when former partnerships became publicly traded companies. It was aggravated with the annulment of Glass Steagall in April 1998 when Citigroup acquired Travelers (which owned Salomon Smith Barney.) These events marked a return to the risk taking on the part of banks that was more common in the 1920s. Spread banking was (and is) neither as exciting nor as profitable as trading.
Contrary to what the Goldman lobbyists would have one believe, the rules are not aimed at reducing profits at Goldman, though they may have that effect. They are designed to make banks and banking safer. If a financial institution prefers to trade for its own account, it has every right to do so; but not as a bank that has access to cheap capital via the Fed window and which holds individual deposits guaranteed by the FDIC.
Other than filling the pockets of traders and senior management, proprietary trading provides little, if any, economic value. At the same time, as we all know, it can create enormous risk – risk that when emanating from banks that are “too big to fail” is borne by taxpayers and shareholders, not by the perpetrators. There is nothing wrong with individuals, private partnerships or even public companies (when the shareholders are fully informed of the risks) from engaging in such activity; so long as their activity does not endanger our financial system. A recent poll of investors, traders and analysts showed that 54% view Goldman in a poor light, so my comments may be seeing as piling on.
Goldman Sachs, in the fall of 2008 and under duress, became a bank, able to access the Fed window. It should be subject to rules governing commercial banks. It always has the option to reconstitute itself as a partnership, or spin off its proprietary desks. But as it is, it has the best of all possible worlds. It is little wonder Goldman doesn’t want the system to change.
Labels: TOTD
posted by Thought of the Day @ 5:40 AM
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