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Volcker Rule End-Arounds Can Be Stopped by Regulators With Sufficient Will

Eric Dash and Nelson Schwartz are shocked, shocked to discover that risky trades will still be allowed, even after the financial reform bill’s passage.

When Congress passed a new financial regulation bill last month, it sought to prevent federally insured banks from making speculative bets using their own money. But that will not stop banks from making bets that some critics deem risky, even as the rules go into effect over the next few years.

That is because many such bets — on the direction of the stock market or the price of coal, for example — are done on behalf of clients. So, the banks say, they will continue to be allowable despite the new restrictions.

Indeed, several trades that were made on behalf of clients went bad for the banks even as the new rules were being debated in Washington this year. JPMorgan Chase and Goldman Sachs, for example, each lost more than $100 million on transactions handled for customers in the period from April to July.

Maybe I’ve just been following this too closely, but I can’t imagine how anyone would be surprised by this at all. The legislation was never meant to end these risky trades, just isolate them, away from banks which dealt with commercial funds. And that is, to an extent, working, with firms dismantling their trading desks and moving them into client-related asset management companies.

It’s true that a lot of these maneuvers look merely like renaming the trade rather than anything fundamental, but if the regulators did their job, the two would go hand-in-hand. Specifically, trades made on behalf of clients from these side businesses and asset management firms would mean that the clients would bear the risk, not the taxpayers. And the bank could make the trade, but their losses would have to be covered by them and them alone – and the asset management firm would not be eligible for any federal rescue.

That would actually end too big to fail. Sadly, it’s unlikely that even another financial crisis would lead to that. All of the rules made about resolution authority and banks being financially responsible for their own bailouts are nice in theory, but in practice, I’d like to see who currently in the US government would have the gumption to enact them.

That said, if regulators wanted to make very strict rules about proprietary trading on behalf of clients, they could – and they could do it right now, with the authority vested in them by Dodd-Frank. The law created a framework, it did not imbue the regulators with the will to enforce it in ways that maintain safety and security for the financial sector. The Volcker rule as written certainly has some loopholes, but on this point, it can be as strong or as weak as the regulators wish.

I would ban the great majority of this stuff if I were emperor. That doesn’t mean that the apparatus ushered in by Dodd-Frank can’t work – if the regulators want it to work.

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David Dayen

David Dayen