The Big Banks reporting earnings this week will be one of the most significant events of 2014. In the big picture, how the banks fare and what their future prospects are could single-handily determine the trajectory and breadth of the recovery we've been hoping for. Even more importantly,
After several fits and starts, the Volcker Rule is finally reality, even if doesn't take effect until July 2015. The big question is whether this regulation will have the teeth to effectively curb the risky proprietary trading of the Too Big to Fail Banks.
After two years of review and lengthy revisions, all five regulatory agencies unanimously passed the controversial Volcker Rule on Tuesday.
The 953-page new version of the Volcker Rule imposes a strict ban on proprietary trading (when banks use their own funds to make trades). In effect, it bans banks from trading for their own gain. Included in the revised version is new wording targeting the sort of risk taking that was responsible for last year's $6 billion trading loss at JPMorgan.
The Too Big to Fail Banks thought they had Congress completely flummoxed by the complexity of their trading strategies. Any rules that emerged from the Dodd-Frank law would be full of loopholes, or utterly toothless. But then one member of the club did something incredibly stupid. Now, for the first time in years, Washington is
The 2010 Dodd-Frank law was conceived with the best of intentions - curb the bad behavior of the Too Big to Fail banks that caused the 2008 financial crisis. Front and center was the Volcker Rule, which was to stop the banks' risky and dangerous proprietary trading. Three years later the Volcker Rule has yet to see the light of day,
On July 21, the Dodd-Frank Act turned three years old.
But, unlike most three-year-olds who can walk and talk, this one hasn't gotten out of the crib yet...
You see, the Dodd-Frank Act was a promise to protect Americans from the excesses and ruthlessness of Wall Street. It was meant to streamline the regulatory process.
But three years later, we are still waiting for its full implementation.
In fact, as of last week, only 155 of 398 rules required by this law are considered final.
That's because instead of focusing on the systemic problems that caused the crisis, the pen to write the bill ended up in the hands of disconnected agencies and lobbyists.
Instead of fixing the serious problems of current law, Dodd-Frank failed to curtail Wall Street - just a few years after a major financial crisis.
At a time when Sen. Elizabeth Warren, D-MA, and Sen. John McCain, R-AZ, have pushed for a new Glass-Steagall Act to reduce risk, some voices like Treasury Secretary Jack Lew argue that the Dodd-Frank bill will alleviate the problems of Too Big to Fail, systemic risk, and cronyism.
But we know that such arguments are spurious at best.
The London Whale trade, as it is informally known, was originally reported as a $2 billion loss. But now The New York Times has reported the loss will total $9 billion -- and maybe more.
But Money Morning subscribers were well aware of the possibility JP Morgan's losses would exceed $4 billion or $5 billion. Money Morning Capital Wave Strategist Shah Gilani repeatedly said this "hedge" was really a bet, and was among the first to predict how large the losses would eventually turn out to be.
Gilani, who hosts the radio show "On the Money!" in addition to his Money Morning duties, had this to say about JP Morgan's ill-conceived bet:
"What it does is shine the light on what is actually happening. It's not the loss in terms of the money, it's the loss in terms of faith for [CEO] Jamie Dimon, that he has been pushing hard against the regulators... in particular to the Volcker Rule, saying there is no need for it and it and that banks have a good handle on their risk... and that we (JP Morgan) don't have a problem with it because we are just hedging."
Just hedging? Gilani certainly doesn't think so.
Gilani said that statement is a flat-out lie and that Dimon has basically lied to Congress in his testimonies over the past weeks.
In the testimony before the House Financial Services Committee last week, Dimon said the London unit had "embarked on a complex strategy" that exposed the bank to greater risk even though it had intended to minimize risk.
And then I called the parents of the Volcker Rule, the Dodd-Frank Act, a "joke."
Well, by the amount of comments I got back from I&I readers - right now, there are about 95,000 of you (and counting) - you'd think I was talking about something really controversial, like contraception, for heaven's sake.
Talk about passionate!
I understand that people get passionate about contraception. After all, without all that passion, we wouldn't need contraception.
But me being passionate about the birth of the Volcker Rule, which I said should never had been conceived, apparently caused a lot of to you think I crossed some moral line.
Not me! I'm not one to ever say anything controversial! And I'm certainly not the kind of guy to wade into the contraception debate.
But, if I was, I'd be a strong advocate for it.
The unwelcome birth of the Volcker Rule is a good example...
For heaven's sake! What's the big deal? After all is said and done, there is only one real problem with it (and I'll get to that in a minute)...
The 300-page draft Rule, named after its champion architect, former Federal Reserve chairman and inflation-fighting icon Paul A. Volcker, is an addition to the ever-evolving masterpiece of legislation (yes, I'm being sarcastic) known as the Dodd-Frank Act.
Now, draft SEC rulemaking and regulatory actions are first submitted to the public for "comment." The SEC collects all comment letters and posts them on their website.
Well, wouldn't you know it, this draft (some might call it "daft") Volcker Rule has caused a flurry of letter writing; letters were due to the SEC by no later than this past Monday evening.
All in all, this august (not the month) regulatory body received 241 detailed comment letters (that's a lot of comment letters) and an astounding 14,479 mostly form letters, as well.
Almost all of the form letters to the SEC, many of which were "personalized" by submitters, were strongly in favor of the Volcker Rule and called for strengthening it and not watering it down by allowing any exemptions.
How do I know that? (No, I didn't read them all.) They resulted from an e-alert campaign to activist supporters of the Americans for Financial Reform group and Public Citizens, who posted appeals on their websites.
Other notable comments in favor of the Rule, and weighing-in in more detail, came from Paul Volcker himself and Senators Carl Levin (D-MI) and Jeff Merkley (D-OR), who championed the Volcker Rule in the Dodd-Frank legislation and in their comments called the draft too "tepid."
The lengthiest comment letter in favor of the Rule (and of tightening it significantly) came in the form of a 325-page love letter from the Occupy Wall Street movement.
However, of those 241 detailed comment letters, most of them came from detractors.
Detractors like individual banks (who normally let their dogs and lobbyists do their biting) and industry groups, such as the Securities Industry and Financial Markets Association (Sifma) and the Center for Capital Markets Competitiveness at the U.S. Chamber of Commerce.
Powerhouse law firm Davis Polk was itself drafted by several banks and Sifma to help draft at least 10 letters on behalf of the cause ("cause" banks want to keep making big bonuses).
Detractors of the Volcker Rule warned of dire consequences for American capital markets, American corporations, the American economy, the world, and the universe beyond even our own little constellation, if the Rule is allowed to curtail their most coveted and conscientious shepherding of their clients' best interests.
Prop Trading, Market Making and the Volcker RuleThe Volcker Rule comes down to this:
The Volker Rule is one of the elements required by the Dodd-Frank financial oversight law, which was written to rein in the sort of excessive Wall Street risk-taking that led to the financial crisis of 2008.
A draft version of the rule was released this week by the U.S. Federal Reserve, which was approved by both the Federal Deposit Insurance Corporation (FDIC) on Tuesday and the Securities and Exchange Commission (SEC) yesterday (Wednesday).
The rule aims to ban proprietary trading, in which the banks traded for their own benefit rather than for the benefit of their customers, but also will address other areas such as hedge fund investing.
Since a significant chunk of the big banks' profits - especially that of Goldman Sachs Group Inc. (NYSE: GS) and Morgan Stanley (NYSE: MS) - come from various forms of proprietary trading, the Volcker Rule stands to cost the industry billions in revenue.
To prevent cheating, complex compliance rules will require that banks prove that all their trading activities are for clients' benefit, and not proprietary. Compliance alone is expected to tack on another $2 billion in costs.
"[The Volcker Rule will] diminish the flexibility and profitability of banks' valuable market-making operations and place them at a competitive disadvantage to firms not constrained by the rule," noted a report by Moody's Corp. (NYSE: MCO).
The rule is named for former Fed Chairman Paul Volcker, who has made the case that such regulations are needed.
The new regulations will deal another blow to an already-struggling industry, which has watched earnings sag as a result of a falloff in equity trading volume, weak demand for loans, and costly legal headaches.
Although there's still time for the Volcker Rule to be tweaked before it takes effect on July 21, 2012, it will fundamentally change how the big banks operate.
The rule's impact on Goldman Sachs and Morgan Stanley will be particularly brutal, especially if the final version imposes broader restrictions.
JPM, the second-biggest U.S. bank by assets, told about 20 traders who work on its commodities trading desk that the company will close the unit, Bloomberg News reported, citing an anonymous source.
The bank eventually will close all in-house trading to comply with new U.S. curbs on investment banks, said the person, who asked not to be identified because New York-based JPM's decision hasn't been made public.
In his Cooper Union speech to Wall Street and the American public yesterday (Thursday), President Obama took pointed aim at opponents of his bank-reform agenda by stating: "Unless your products depend on bilking people, there's little to fear from these reforms."
Whether or not the timing of the Goldman Sachs fraud case was politically motivated, or whether or not President Obama was referring to Goldman with his "bilking" comment, one thing is for sure: The president and his administration are taking the reform fight to the Street.
At stake in this fight is the future of our capital markets, the health of the U.S. economy and the direction of the U.S. stock market.
To see how the Obama bank-reform push could perpetuate the bull market, please read on...