Fed makes a risky bet on banks
That banks can’t be completely trusted to judge the risks they take was a painful lesson regulators learned from the Great Recession. Or so it seemed.
After financial institutions’ casino-like investments in complex derivatives and questionable mortgage lending nearly collapsed the global financial system a decade ago, Congress established the Volcker Rule as part of the Dodd-Frank reform act in 2010. The Volcker Rule restricted banks from speculating with depositors’ money. It limited them to trading on behalf of customers — market making — or to hedge potential risks from swings in interest or foreign currency rates. The banks were also banned from investing in hedge funds and private equity funds.
Under the rule, in force since 2015, any security held for less than 60 days is deemed a proprietary trade — speculation with the bank’s accounts. More important, banks had to demonstrate to regulators that such trades were for permitted purposes and were not the product of some clever trader’s hunt for enhanced returns.
Not any more, it seems. Under a revision proposed by the Federal Reserveon Wednesday, banks would establish their own risk limits and determine whether such trades are compliant, rather than running every trade they make on behalf of clients by the regulators.
In other words, trust them, they’re risk-taking experts.
There’s no question that the banks have had to function within a more cumbersome regulatory harness under Dodd-Frank. Including the Fed, five agencies are involved in enforcing Dodd-Frank and its Volcker component: the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission and the Commodity Futures Trading Commission. And all must approve the proposed revision.
That’s a sea of bureaucracy, but the scope of the damage committed by financial institutions a decade ago — consider the hundreds of billions of dollars in bailouts — required a vigorous response. It still does. And there’s no good reason to end it.
If banks are overly burdened by this regulatory load, it’s not apparent in their robust results.
Yet they have successfully argued that the rule has restricted liquidity, and choked their ability to trade in complex products such as derivatives, which are often used by banks and their clients to offset risk.
When markets got more volatile earlier this year, though, there seemed to be more than adequate liquidity available. Keefe, Bruyette & Woods, a financial services firm, reported that revenues from stock trades increased 37.5 percent for the median American bank in the first quarter of 2018.
“Total revenue for the US banks was the highest since 2009,” KBW noted.
Similarly, JP-Morgan Chase said that its trading revenue increased 13 percent, to $6.57 billion from $5.82 billion from the prior year’s quarter. Aided by tax cuts, JP-Morgan posted a record $8.71 billion in quarterly earnings. Other big banks, with the exception of the tarnished Wells Fargo, were putting up similarly admirable profit numbers. And rising interest rates point to more to come.
So why rush to undo the proprietary trading safeguard? The former Federal Reserve chairman Paul Volcker, who helped write the rule, is sympathetic to the banks’ desire to unwind some of the red tape. Still, he warned that deregulation should not “undermine the core principle at stake — that taxpayer-supported banking groups, of any size, not participate in proprietary trading at odds with the basic public and customers’ interests.”
It’s also disappointing to see that this proposal has the backing of the Fed chairman, Jerome Powell, and the former Obama official and board member Lael Brainard, who both know from the experience of the last downturn the possible risks here. The Great Recession amply demonstrated that when banks chose between proprietary trading and customers’ interests, the customers lost out. And we haven’t even had any kind of market jolt to thoroughly test what would happen under the existing rules.
Congress has already rolled back some Dodd-Frank risk regulations on all but the largest banks, in a law President Trump signed last month.
Mr. Volcker, a truly wise man who conquered rampant inflation as Fed chairman from 1979 to 1987, said he had faith that proprietary trading would still be amply regulated and “the final rule will strongly maintain that position by, as intended, facilitating its practical application.”
Forgive us for being less trusting, Mr. Chairman. There’s a saying that the time to fix a leaky roof is when the sun is shining. And our economy is, if not shining, certainly sunny. The fear is that, when it comes to our financial system, both our Congress and our regulators are now loosening the shingles.