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February 13, 2012

Strong Volcker Rule Needed to Halt Wall Street’s Casino Bets

Better Markets today urged federal regulators to strengthen its proposed Volcker Rule that would ban proprietary trading, arguing that such protections are needed to prevent another financial crisis from occurring again and ending Wall Street bailouts.

“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,” said Dennis Kelleher, president and CEO of Better Markets.

The public-interest group outlined steps in a comment letter to regulators that would prevent megabanks from circumventing the rule, which is a crucial element under the Dodd-Frank financial reform law. It bans banks from trading from their own account as opposed with their customer’s money.

“The Volcker Rule’s prohibition is also narrowly targeted at a particularly pernicious, dangerous and, indeed, lethal type of bank behavior:  proprietary trading where banks place huge bets with borrowed money that promise enormous upside, but risk even greater downside and taxpayers get stuck with the bill,” the letter states.

Better Markets in its letter highlighted a few areas where the rule needed to be strengthened to prevent loopholes:

• The source of all income from “market making” must be limited to spread, fees, and commissions. The rule allows for a small exemption for banks to provide for market making, but industry is asking for greater loopholes to engage in proprietary trading. Additionally, high-frequency trading also should fall under prohibited activities.

• The enforcement provisions should be toughened to serve as a deterrent, not just the cost of doing business on Wall Street. Regulators should create a sliding scale of penalties for violations, including fines of 10 times of the gross profit or loss from a trade, a six-month ban for the trader, and a cease-and-desist order for the firm.

• The rule must include strong leverage limits and liquidity requirements for trading activities. Broker-dealers historically have been highly leveraged, willing to depend on short-term borrowing to fund longer-maturity and less-liquid assets. That makes them susceptible to a run on the bank during times of stress.

• The hedging exemption must be more narrowly drawn so it is not used to disguise speculative trading.  The hedge must be linked to the position it is meant to hedge. Banks should not be allowed to conduct portfolio hedging for supposed broader risks.

Volcker Rule explainer

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