The Volcker Rule & AIG: It’s Not About Prop Trading
Courtesy of rc whalen at Zero Hedge
Watching the President announcing his proposals to forbid commercial banks from engaging in proprietary trading, I am reminded of the reaction by Washington a decade ago to the Enron and WorldCom accounting scandals, namely the Sarbanes-Oxley law. The final solution had nothing to do with the problem and everything to do with the strange politics of the capital city and the national Congress.
The basic problems of the Enron/WorldCom scandals was financial fraud and the use of off-balance sheet vehicles to commit same. By responding with more stringent corporate governance requirements, the Congress was seen to be responding — but without harming Wall Street’s basic business model. In that regard, note that today former SEC chairman Bill Donaldson was standing next to President Obama on the dais, along with Paul Volcker and Treasury Secretary Tim Geithner.
A decade on, we have the same basic problem, namely the use of OBS vehicles and OTC structured securities and derivatives to commit financial fraud via deceptive instruments and poor or no disclosure. Another name for OTC markets is “bucket shop,” thus the focus on prop trading today in the President’s comments was entirely off target. The Volcker Rule, at least as articulated today, does not solve the problem. And what is the problem?
The poster child victim for this latest round of rape and pillage by the large dealer banks is, of course, American International Group (AIG) along with many, many other public and private Buy Side investors. The FDIC and the Deposit Insurance Fund is another large, perhaps the largest victim of the structured finance shell game. Prop trading was not the problem with AIG nor the cause of the financial crisis, but instead the rancid production from the securities underwriting side of the business.
Not a single major securities firm or bank failed due to prop trading during the past several years. Instead, it was the customer side of the business, usually the mortgage conduit, that was the problem, the securities underwriting side of the business that the Volcker Rule conveniently ignores. And this is the one area that you will most certainly not hear President Obama or Bill Donaldson or Chairman Volcker or HFS Committee Chairman Barney Frank mention. You can torment prop traders, but leave the syndicate desk alone.
The dealers, starting with Goldman Sachs (GS) and Deutsche Bank (DB) were seemingly sucking AIG’s blood for years, one reason why the latest response by Washington has nothing to do with either OTC derivatives, structured assets or OBS financial vehicles. And this is why, IMHO, the continuing inquiry into the AIG mess presents a terrible risk to GS, DB and the other dealers, especially when you recall that the AIG insurance underwriting units were lending collateral to support some of the derivatives trades. Deliberately causing a loss to a regulated insurance underwriter is a felony in New York and most other states in the US. Thus the necessity of the bailout.
If you accept situations such as AIG and other cases where Buy Side investors (and, indirectly, the US taxpayer) were defrauded through the use of OTC derivatives and/or structured assets as the archetype “problems” that require a public policy response, then the Volcker Rule does not address the problem. The basic issue that still has not been addressed by Congress and most federal regulators (other than the FDIC with its proposed rule on bank securitizations) is how to fix the markets for OTC derivatives and structured finance vehicles.
Neither prop trading nor market share are the causes of the financial crisis. Instead, opaque OTC markets, deliberately deceptive structured financial instruments and a general lack of disclosure are the problems. Bring the closed, bilateral world of OTC markets into the sunlight of multilateral, public price discovery and require SEC registration for all securitizations, and you start down the path to a practical solution. But don’t hold your breath waiting.
