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Why Is “Fail Whale” Trade a Problem for Romney, and Not the Administration That Watered Down the Volcker Rule?

The fallout from JPMorgan Chase’s “Fail Whale” trade (I’m trying to coin this phrase, so help me out, will you?) continues. But there’s been a thread in one section of the liberal blogosphere that has confounded me. For some reason, writers are trying to position this as a problem for Mitt Romney. Here’s a representative sample:

This is exactly the type of major loss of depositor money that the Obama administration sought to ban with one of the major planks of its 2010 Dodd-Frank Wall Street reform law — the Volcker Rule, named after former Fed chairman Paul Volcker. And that’s bad news for Romney, who wants to repeal the whole law, Volcker Rule and all […]

The Volcker Rule is still being developed by regulators, won’t be implemented until late July at the earliest. It’s intended to ban banks from gambling with depositor funds in what are known as proprietary trades. Dimon claims that the investment in question wouldn’t have violated the rule had it been in effect — he says the bets JPM made were meant to hedge against potential losses in other investments. But finance experts have cast doubt on that claim, and Dimon himself admitted that the incident will provide ammunition for the Volcker Rule supporters.

It’s true that Romney wants to repeal Dodd-Frank, including the Volcker rule, and it’s true that repealing any limits on proprietary trading would be a stupid move, especially in light of the Fail Whale trade. But this would be a better argument if the Fail Whale didn’t happen on the Obama Administration’s watch. In fact, it did, and Dimon’s insistence that the trade would be Volcker rule-compliant is probably accurate. And we have the federal regulators to blame for that.

As I pointed out in my previous post, Carl Levin and Jeff Merkley, the authors of the Volcker rule that made it into Dodd-Frank, already said that portfolio hedging – what amounts to what was on display here with the Fail Whale – should have been banned by their legislation. But the proposed rule allowed it, creating a giant loophole that effectively guts the Volcker rule. In other words, the executive branch agencies are directly responsible for a trade like this being allowable. So how is this a problem for Romney, then?

As Felix Salmon points out, the complex nature of derivatives trading can always be mitigated by big, dumb rules:

Your sophisticated platform needs to be built on a foundation of dumb rules: simple limits on how big any one position can get, on how much exposure you can have to any one counterparty, or in general on any trade which is based on the hypothesis that your desk is smarter than anybody else on Wall Street.

Those kind of rules won’t prevent all blow-ups, of course, but they’ll help. They would have prevented this one, and they would have put an end to Jon Corzine’s disastrous MF Global trades, as well.

The problem is that traders hate dumb rules, because they cap the amount of money they can make. And traders have enormous power at investment banks these days, because they make the lion’s share of the profits.

The Volcker rule as it’s being implemented is the opposite of a big, dumb rule. It’s a regulatory haze full of loopholes and concessions that render it fairly useless. If you’re going to put the blame for that on any one person, it wouldn’t be Mitt Romney.

The SEC has opened an investigation into the Fail Whale trade. Let me predict the outcome: a fine in the millions of dollars, and a “neither admit nor deny wrongdoing” clause tucked inside. If that. By the way, the investigation has nothing to do with the Volcker rule, but the public disclosures of the losses.

It’s not for no reason that investors around the world would prefer Obama to Romney in the Presidential election.

UPDATE: Levin and Merkley Confirm: We Didn’t Intend Fail Whale Trades To Be Legal

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David Dayen

David Dayen