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March 30, 2017

SIFMA, Chamber of Commerce & ICI Endorse the Volcker Rule Banning Proprietary Trading

It’s rare that a question during a Congressional hearing leaves an entire panel of witnesses silent.

But, that is exactly what happened when Representative Jim Himes’ (D-CT) questioned the panel of five witnesses during a hearing by the House Financial Services Subcommittee on Capital, Markets, and Investment.  The subject of the hearing was “Examining the Impact of the Volcker Rule on Markets, Businesses, Investors and Job Creators.” 

The Volcker Rule prohibits FDIC insured banks from engaging in proprietary trading, which is using insured deposits to make huge, almost always highly leveraged bets to increase their bonuses.  Because this prohibition reduces their bonuses, Wall Street hates it and has been relentlessly trying to kill the rule since it was first introduced and this hearing was just the latest in that unending attack.

There is, however, no economic or social value in proprietary trading.  In fact, prop trading is dangerous because when those bets go wrong the losses cost the bank capital, weaken the stability of the bank and can lead to failure and taxpayer bailouts, as was seen in 2008 financial crash.  The clearest recent example of a reckless high risk proprietary bet using FDIC insured deposits was JP Morgan Chase’s “London Whale” trading scandal, which was a complex trillion-dollar bet that lost the bank more than $6 billion. 

A problem arises, however, because not all prop trading is as clear as the London Whale.  For example, while banks are permitted to make markets in securities and bonds for their customers, when are they doing that and when are they using the possibility of that to disguise their own prop trading to juice their bonuses?  Put differently, when are inventories genuinely related to actual near term customer needs and when are they just a bet by the bank?

To make risks of prop trading more understandable, Rep. Himes used an analogy at the hearing of a Toyota car dealership that sells 100 cars per month.  To ensure he has enough inventory for near term customer demands, Himes posited that the dealer keeps about 120-130 cars on the lot.  However, it wouldn’t make sense, he said, for that dealer to keep 400 cars on the lot as well a luxury automobile.  It’s not consistent with reasonably expected near-term customer demand.  To that end, he asked the witnesses, “Isn’t the fundamental idea that banks ought to be able to keep enough inventory to make markets but they shouldn’t have a lot more volatile assets on their books. Isn’t that fundamental principle pretty reasonable?”

Ronald J. Kruszewski, chairman and CEO of Stifel Financial Corporation, the witness representing Wall Street’s powerful lobbyist SIFMA, unsurprisingly could offer only the usual Wall street-scripted talking points, saying that it was up to the dealer to determine demand, which, of course, didn’t answer the question.

And that’s where things became really interesting (Be sure to check out the video of Himes’ questioning, which begins at about the 1:18:00 mark.) as Rep. Himes asked in his follow-up question:

I understand that, and of course there’s a pretty dramatic difference between my Toyota dealer and the bank, which is that the Toyota dealer is disciplined by the fact that if he keeps 700 cars on the lot and it goes wrong, he’s out of business.  And the FDIC is not there to bail him out.  The TARP is not there to bail him out.  The 1994 Peso rescue is not there to bail him out.  So, I guess my big question, and this is for the panel as a whole, I’ve heard a lot of talk about short-term proprietary trading.  Does anybody here think the FDIC-insured institutions should be taking long-term proprietary bets?

There was total silence from the entire panel of witnesses, to which Himes responded, “OK, the silence there I am going to take to be a no.”  Not one witness thought that “FDIC-insured institutions should be taking long-term proprietary bets.”  Thus, SIFMA, the Chamber of Commerce and the Investment Company Institute (ICI) agreed that FDIC-insured institutions should NOT be taking long-term proprietary bets, which is precisely what the Volcker Rule prohibits.   (One witness, Marc Jarsulic, Vice President for Economic Policy at the Center for American Progress, didn’t need to answer because this was his position already, which he had addressed in his testimony.)

With this acknowledgement, Rep. Himes cut to the real issue that serious, reasonable people should be focused on: 

“[It] is not on the regulators to explain why insured institutions should not be able to take proprietary bets…. The burden is on the industry to come up with constructive ways, if there are more constructive ways, in determining the legitimate inventory as opposed to making the argument that we should take away the idea that proprietary trading is somehow permissible inside a depository institution.”

That’s the point:  the industry should stop trying to kill the Volcker Rule, which would unleash FDIC insured banks to engage in unlimited, high-risk, dangerous prop trading with depositors’ money.  If there are better ways to distinguish between permissible genuine market making and prohibited prop trading, then that’s the discussion we should be having.  SIFMA’s representative, Mr. Kruszewski (who, after testifying about prop trading for two hours remarkably admitted at the end of the hearing that his firm doesn’t even engage in prop trading), the Chamber of Commerce, represented by Thomas Quaadman, and the ICI should focus on constructive ideas rather than destructive (and baseless) attacks on a sensible rule that they in fact agree with and which protects taxpayers, the financial system and our economy. 

Climate & ESG


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