Friday, December 28, 2012

Did losses on "London whale" trade succeed in defanging bank lobbying when financial crisis couldn't?

In his Wall Street Journal article, Scott Patterson lays out how the losses sustained by JP Morgan on its "London whale" trade effectively defanged the bank lobbying efforts when it came to implementation of the Volcker Rule.

Regular readers know that there are two elements to each rule:  what the rule says and how it is enforced.

Your humble blogger showed how this would work for the Volcker Rule.  The rule says that banks are not allowed to engage in proprietary trading.  This is enforced by requiring the banks to provide ultra transparency and disclose their current global asset, liability and off-balance sheet exposure details.  With this information, market participants could see if the bank were engaged in proprietary trading and exert discipline to stop this proprietary trading.

Compare this with the 200+ pages that is going to emerge from the bank regulatory complex and that bank examiners are suppose to enforce.  Enforcement which will be problematic because one of the cardinal rules of bank examiners is not to approve or disapprove of an exposure taken by a bank because this gets the bank examiners into allocating capital across the financial system.

Which rule and enforcement mechanism looks more likely to be successful in permanently ending proprietary trading by the banks?

The bank lobby already won when they ended up with a 200+ page rule from the bank regulatory complex.  What the "Whale" trade cost the banks is that it will be a little harder for them to engage in proprietary trading.
Wall Street banks entered 2012 confident they could stall a wave of rules that they feared would hurt profits. But they are ending the year largely resigned that their activities will be constrained and monitored more closely by the government. 
One big reason for the change: J.P. Morgan Chase & Co.'s "London whale" losses. 
The bad trades, ultimately resulting in about $6 billion in losses, disrupted the banks' campaign against the Dodd-Frank financial overhaul, according to regulators, lawmakers and close observers of policy debates in Washington. 
I find this a stunning statement for the simple reason that the banks blew up the financial system prior to the beginning of the financial crisis on August 9, 2007.

Apparently, the regulators tasked with writing the Volcker Rule forgot this and needed to be reminded by the losses on the London whale trade.
The trades damaged the reputation of J.P. Morgan, which suffered less than other banks from the financial crisis, and its chief executive, James Dimon, during a crucial period of policy debate in Washington, putting critics of Dodd-Frank on the defensive. 
Before news of the whale losses emerged, banks were arguing, with some success, that too-tight regulations were crimping lending during a time of slow growth....
And what exactly does banning proprietary trading have to do with crimping lending?

Ending the banks proprietary trading would in fact free up capital that could be used to support lending as the banks would be forced to shed the assets they bet on.
Perhaps the most significant fallout was on the "Volcker rule," which bans banks from making bets with their own money. While the final version of the Volcker rule hasn't been released, people with knowledge of the latest version said that it is likely to be more restrictive of bank's trading activities and might not allow broad hedging of bank portfolios.
Hello, it takes two paragraphs to both write the rule and its enforcement mechanism (see above).

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