Traders hooked on insured deposits demonstrates why Volcker Rule needed

Bloomberg carried an exclusive article explaining how traders on Wall Street have become hooked on deposits to support their trades and demonstrating why the Volcker Rule is needed.

At its heart, the Volcker Rule is all about ending this reliance on insured deposits and preventing traders from gambling using these insured deposits.

trading on Wall Street relies on borrowed money, or leverage, that can be obtained cheaply as long as the traders belong to a conglomerate such as Bank of America Corp., JPMorgan Chase & Co. (JPM) or Citigroup that gets federally insured deposits. 

 Jefferies Group Inc. (JEF), a securities firm that isn’t part of a bank and can’t turn to the Federal Reserve for help, currently is charged more to borrow in the credit markets. 

“If you divorce them from the mother ship, you’d also be divorcing them from the government at the same time, and that’s where the subsidy is,” Cornelius Hurley, director of the Morin Center for Banking and Financial Law at Boston University, said in a telephone interview. “The funding advantage is the key.”...

Jefferies’s bond yields show that it costs the firm 5.83 percent to borrow until 2021. That’s more than the 4.38 percent yield on 2022 debt issued by Goldman Sachs. While Bank of America has the same Baa2 credit rating from Moody’s Investors Service as Jefferies -- two levels below Goldman Sachs’s A3 grade -- its 2022 bonds yield 4.01 percent....

There is no reason that the government should offer a funding advantage to one set of traders over another.  Particularly, when offering the funding advantage puts the taxpayer at risk.

About 99 percent of JPMorgan’s $79 trillion derivatives book is in its deposit-taking subsidiary, according to data as of June 30 compiled by the Office of the Comptroller of the Currency. The figure for Bank of America is 71 percent. 

When Merrill Lynch’s credit rating was lowered by Moody’s last September, the company responded by seeking permission to move some of its derivatives contracts to the higher-rated and federally backed Bank of America NA subsidiary. The Fed signaled that it favored granting the request, while the FDIC, which would have to pay depositors if the bank subsidiary failed, objected, people with knowledge of the matter said at the time. 

“For a lot of the activities that these companies engage in, the confidence of their counterparties is really confidence not in them, but confidence in the government bailing out their affiliated bank,” Boston University’s Hurley said.

Please note how the Fed favors putting the taxpayer at risk and the FDIC opposes putting the taxpayer at risk. I wonder which one is fighting for the tougher version of the Volcker Rule.