Banks Fought the Volcker Rule and Banks Won

Paul Volcker took on risky trading by the banks, and risky trading won.

Volcker, the former Fed chief, warned this winter that risky trading by banks must be reined in. A version of his plan survived the Senate vote Thursday night, but it's not going to be enough to keep the biggest banks from rolling the dice with your money on the line.

The financial reform legislation passed by the Senate Thursday includes the so-called Volcker rule, which would restrict banks' ability to mint money on their trading desks. The bill, backed by Senate Banking Committee Chairman Chris Dodd, D-Conn., also contains a provision that would force banks to spin off their hugely profitable derivatives businesses.

Risky trading 1, Volcker 0

When the dust settles and the final bill is signed by President Obama this summer, Wall Street expects the changes to cost it perhaps billions of dollars in annual profits. Even at a time when the six biggest banks made almost $19 billion in a single quarter, that's not chump change.

Yet there's no reason to believe the reforms will address the casino mentality that has prevailed throughout this decade -- and no reason to expect bankers to stop digging up new ways to trade their way to giant bonuses. Indeed, few expect the derivatives provision to make it into the final bill in its current form.

Risky trading by banks lives on, and how.

"There are a lot of elements of risk that haven't been touched" by the legislation, said Peter Cohan, who teaches business strategy at Babson College in suburban Boston. "What about limiting the amount banks can borrow? What about credit default swaps?"

Outsize leverage was indeed part of the crisis, and regulators are now pledging to make banks hold more capital against their assets to limit the risk that the industry will get as pumped-up as it did before the housing bubble burst a few years back.

But the Senate had a chance to pass much stronger measures that would have forced the breakup of giant banks and prohibited them from engaging in some high-risk activities with their customers' money. Proponents of those efforts were left bemoaning an opportunity lost.

After all, the history of financial crises shows without a doubt that "too much borrowing leads to trouble," as Cohan said. And it also shows that regulators, even well-intentioned ones, often miss the boat on the risks that are building up in the system until it's too late.

"We have missed an opportunity to strengthen that provision by putting in statute, without the ability of agencies to modify, prohibitions on risky trading by banks, and strict limits on such trading by nonbanks," Sen. Carl Levin, D-Mich., said in a speech in the Senate Thursday night.

Levin and Sen. Jeff Merkley, D-Ore., co-sponsored a measure that would have strengthened the Volcker rule by forcing banks to get out of the business of trading for their own account rather than for the sake of their customers. But it never came up for a vote.

While the Senate vote will surely hamstring the banks to some degree, it's clear that it doesn't go as far as it could have. What's more, the flash crash earlier this month remains unexplained, at a time when the lion's share of stock trading is done by computers that hold stocks for just seconds. Who knows what might happen next in this wild market of technology run amok?

"It's getting a little scary out there for people who try to invest and for institutions like pension funds that have to make a return," said Cohan.

And so the conditions that allow the banks to rake in outsize profits even as their loan books shrivel remain largely unaddressed.

Bank stocks such as Goldman Sachs (GS), Morgan Stanley (MS), and JPMorgan Chase (JPM) were up 4-5% in early afternoon trading Friday. They may be on the upswing for any number of reasons, including a welcome pause in the flight to safety trade.

But there's no doubt that owners of the big trading houses are breathing a sigh of relief. The rest of us? Not so much.

Back to main column Filed under Uncategorized 8 Comments | Add a Comment | Email Facebook Twitter Digg Buzz Up! var shared_button = SHARETHIS.addEntry({ title: storyinfo.title, summary: storyinfo.summary, icon: storyinfo.icon }, {button:true} );

come november, all the bums in DC will be thrown out. and then wall street thieves will be used to plug up the hole 5000 feet underwater.

Posted By sillyone, NYC : May 21, 2010 4:54 pm

This article gets it completely wrong. Proprietary trading will be banned from bank holding companies. Bank holding companies cannot be a sponsor in any way of hedge funds or private equity funds. The Fed still needs to issue specific rules but the language is clear. The derivatives ban will most likely be written out of the final bill but banks still will not be able to trade derivatives on their own account, only to hedge risks (which is an entirely legitimate function of market makers).

Furthermore, the Collins amendment (which will hopefully survive conference) mandates that the Federal Reserve create leverage and risk-based capital regulations.

Posted By Michael Green, Fairfax, VA : May 21, 2010 4:18 pm

Funny, reducing the risk will cost the banks billions, but how much did it cost the banks, the taxpayers, and the rest of the world with the risk?

Perhaps 4 trillion?

Posted By LicensedToSteal, West Palm Beach FL : May 21, 2010 4:07 pm

Bucket shops were illegal 100 years ago but our politicians (Bill Clinton, Phil Grahm) and trusted experts (Alan Greenspan) allowed CDS/CDO derivitives to trade unregulated through enactment of the Commodities Futures Modernization Act. Selling property that you don't own is illegal and anyone who profitted from this adventure should be prosecuted under RICO statutes. But our politicians and regulators have been bundled up as derivitives and sold.......care to bet on the outcome?

Posted By John, San Francisco, CA : May 21, 2010 4:06 pm

Funny, reducing the risk will cost the banks billions, but how much did it cost the banks, the taxpayers, and the rest of the world with the risk?

Perhaps 4 trillion?

Posted By JEM, West Palm Beach Florida : May 21, 2010 4:03 pm

I was just wondering something. Perhaps there is a real journalist that could actually do a indepth piece about this. The economy is a bit like one of the Hollywood-ish wannabe actors right now. It is addicted to credit and it could take years on a methadone program to be completly free. If we just clamped down cold turkey the market drops 70% because the balloon pops instantly.

Posted By Knghtshingrmour, Los Angeles : May 21, 2010 3:42 pm

If I offer a cop $1000 to not write me a speeding ticket, it is called "Bribery".

If I offer a Judge $1000 to waive the ticket, it is called a "Campaign contribution".

If I offer a Senator $1000 to make writing speeding tickets illegal, it is called "Lobbying".

Posted By Matt, Hartford CT. : May 21, 2010 3:16 pm

It looks like the lobbyists earned their big fat paychecks this week. Once again the villains get off with a slap on the wrist while the rest of America is burdened with their junk! I engaged in the kind of activities the banks did I would be in a soup kitchen line right now. It's funny how the American government consistently fails it citizens. This is truly the best government money can buy!

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Colin Barr Colin Barr has covered finance for Fortune.com since November 2007. Previously he was a writer and editor for TheStreet.com, winning a 2006 Society of American Business Editors and Writers award for "The Five Dumbest Things on Wall Street," and for Dow Jones Newswires. He is a 1991 graduate of Penn State and lives in Port Washington, N.Y., with his wife Meena Bose and their two kids. Email This Author Subscribe to Street Sweep: RSS feed cnnad_createAd("304081","http://ads.cnn.com/html.ng/site=cnn_money&cnn_money_brand=fortune&cnn_money_pagetype=blog&cnn_money_position=336x600_rgt&cnn_money_rollup=markets_and_stocks&cnn_money_section=blogs&cnn_money_subsection=wall_street¶ms.styles=fs","600","336"); Most Popular MostRead MostCommented Editor'sPicks What's really behind SEIU's Bank of... More Why Wal-Mart's sales should have everyone... More Toyota's Tesla stake heats up the electric... More Climate hacking for profit: a good way... More 2010's coming stock market crash: 1987... More Just got laid off? Get better severance More 2009 Fortune 500: Full list More World's Most Admired Companies 2009 More The world's largest companies More How to work better with Gen Y More Hey Facebook! Here's your privacy redesign MoreThe coming gold bust MoreHow Stanford is worse than Madoff More6 big oil spills, and what they cost MoreAt Ford, bragging about quality is Job... More var MPlinkSet0 = new Array(); var MPlinkSet1 = new Array(); var MPlinkSet2 = new Array(); MPlinkSet0 = document.getElementById("mostPop0").getElementsByTagName("a"); MPlinkSet1 = document.getElementById("mostPop1").getElementsByTagName("a"); MPlinkSet2 = document.getElementById("mostPop2").getElementsByTagName("a"); for (i=0;i cnnad_createAd("327577","http://ads.cnn.com/html.ng/site=cnn_money&cnn_money_position=336x280_quigo&cnn_money_rollup=business_news&cnn_money_section=blogs&cnn_money_subsection=quigo¶ms.styles=fs","280","336"); function chooseMagSourceID() { var subsUrl = 'FOnb?source_id=1'; if ((location.pathname == '/magazines/fortune/')||(location.pathname == '/magazines/fortune/index.html')) subsUrl = 'FOnb?source_id=22'; else if (location.pathname.match('/magazines/fortune/investing')) subsUrl = 'FOnb?source_id=39'; else if (location.pathname.match('/magazines/fortune/tech')) subsUrl = 'FOnb?source_id=40'; else if (location.pathname.match('/magazines/fortune/fortune500')) //including yearly rankings subsUrl = 'FOnb?source_id=42'; else if (location.pathname.match('/magazines/fortune/management')) subsUrl = 'FOnb?source_id=41'; else if (location.pathname.match('/magazines/fortune/rankings')) subsUrl = 'foab?source_id=34'; else if (!location.pathname.match('_archive') && location.pathname.match(/(\..+)?\/\d{4}\//)) subsUrl = 'foab?source_id=34'; else if (location.pathname.match('_archive') || location.pathname.match('toc.html')) subsUrl = 'foab?source_id=52'; else if(location.hostname.search(/\.blogs(\..+)?\.cnn\.com$/) != -1) subsUrl = 'FOnb?source_id=21'; var buttonString = '' var parentDiv = document.getElementById('fortuneSubscribe'); var targetDiv = new Array(); targetDiv = parentDiv.getElementsByTagName('div') var i=0; for(i=0; i Home | Contact Us | Advertise with Us | Corrections | Career Opportunities | Site Map RSS | Email Delivery | Portfolio | Podcasts | Mobile | Widgets | User Preferences | Special Sections chooseFortEKeyFooter(); | Magazine Customer Service | Download Fortune Lists | Reprints | Conferences | Business Leader Council msQueueManager.init('requestFrame', ms_blankURL); Please create a screen name to access this feature.

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This article gets it completely wrong. Proprietary trading will be banned from bank holding companies. Bank holding companies cannot be a sponsor in any way of hedge funds or private equity funds. The Fed still needs to issue specific rules but the language is clear. The derivatives ban will most likely be written out of the final bill but banks still will not be able to trade derivatives on their own account, only to hedge risks (which is an entirely legitimate function of market makers).

Furthermore, the Collins amendment (which will hopefully survive conference) mandates that the Federal Reserve create leverage and risk-based capital regulations.

Funny, reducing the risk will cost the banks billions, but how much did it cost the banks, the taxpayers, and the rest of the world with the risk?

Perhaps 4 trillion?

Bucket shops were illegal 100 years ago but our politicians (Bill Clinton, Phil Grahm) and trusted experts (Alan Greenspan) allowed CDS/CDO derivitives to trade unregulated through enactment of the Commodities Futures Modernization Act. Selling property that you don't own is illegal and anyone who profitted from this adventure should be prosecuted under RICO statutes. But our politicians and regulators have been bundled up as derivitives and sold.......care to bet on the outcome?

Funny, reducing the risk will cost the banks billions, but how much did it cost the banks, the taxpayers, and the rest of the world with the risk?

Perhaps 4 trillion?

I was just wondering something. Perhaps there is a real journalist that could actually do a indepth piece about this. The economy is a bit like one of the Hollywood-ish wannabe actors right now. It is addicted to credit and it could take years on a methadone program to be completly free. If we just clamped down cold turkey the market drops 70% because the balloon pops instantly.

If I offer a cop $1000 to not write me a speeding ticket, it is called "Bribery".

If I offer a Judge $1000 to waive the ticket, it is called a "Campaign contribution".

If I offer a Senator $1000 to make writing speeding tickets illegal, it is called "Lobbying".

It looks like the lobbyists earned their big fat paychecks this week. Once again the villains get off with a slap on the wrist while the rest of America is burdened with their junk! I engaged in the kind of activities the banks did I would be in a soup kitchen line right now. It's funny how the American government consistently fails it citizens. This is truly the best government money can buy!

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