The Real Volcker Rule: No Gambling with the Public’s Money

By | May 14, 2012

Pundits and Wall Street reforming politicians are crowing: Wowie! Jamie D has fought for weak regulations, especially a weak Volcker rule, but now Wall Street’s goose is cooked! We’re going to get a strong Volcker rule!

But that gleeful analysis amounts to: We lost the war but hey, we might still win a battle!

Former Fed Chair Paul Volcker fought incredibly hard for something much more powerful than even a strong version of the so-called Volcker rule. Volcker pushed for a return of Glass-Steagall, a law that until 1999 prevented the public financing of Wall Street gambling. Glass-Steagall/Volcker-for-real stands for the idea that when a company’s cash (deposits) is guaranteed by the government and the company has access to incredibly cheap government money, under no circumstances can the company be allowed to gamble with it.

Let’s be clear: Glass-Steagall wouldn’t prevent gambling addicts like Jamie Dimon from losing big bets. Crucially, however, Glass-Steagall would make the cost of placing those bets market rate, and make the gambler’s shareholders take the loss.

It’s a tremendously sad testament to the power of the banks that first they killed the return of Glass Steagall in favor of a ban on gambling for their own profit (a strong Volcker rule) and then used their lobbying prowess to eviscerate the rule.

FDIC Vice-Chairman Renews Glass-Steagall Push

Well, common sense is rising again. Shahien Nasiripour of the Financial Times interviewed Thomas Hoenig, Vice Chair/second in command at the FDIC recently, and Hoenig said

“that broker-dealer activities [that is, trading in the markets] should be cleaved off from banks, particularly large, systemic financial institutions.”

That is, Hoenig called for a return of Glass-Steagall. Why? Because

“’In a crisis, who will absorb the loss?’”

In case you’re not sure, the answer is you, me, and hundreds of millions of others. Not that we share in bankers’ profits, of course, just the losses.

Hoenig then pointed out the obvious, foreshadowing Jamie Dimon’s mea culpa:

“‘If management cannot adequately monitor and control their risk, it is unreasonable to expect supervisors to do so in their place,’”

Glass-Steagall is the key to preventing future bailouts because it makes the implicit government guaranty the big banks now have less credible. See, right now, between the FDIC and the discount window, there’s a mechanism in place to honor the implicit guaranty. Spin off the trading operations, and we’re back in overt bailout territory, a political minefield many won’t walk through again. As Hoenig explained  the guaranty that is the only reason the bailed out banks’ trading operations haven’t yet bankrupted the banks:

“without government support, Mr Hoenig argued…investors and counterparties would then appropriately price for the risk that these institutions could fail, eventually leading to more disciplined trading and less risky activities.

“I’m not impressed by the markets’ smarts, but I’m very impressed by its harshness,” Mr Hoenig said.”

Perhaps worse than the standing risk of stealth bailouts driven by bailout-empowered greed, every day the present arrangement continues the banks get to leech off America quite extravagantly, as Sheila Bair detailed in the Washington Post:

For several years now, the Fed has been making money available to the financial sector at near-zero interest rates. Big banks and hedge funds, among others, have taken this cheap money and invested it in securities with high yields. This type of profit-making, called the “carry trade,” has been enormously profitable for them.

Shifting Gambling Risks to You and Me

Last fall Bank of America backed up its bets with the money you and I have deposited with it, and which the FDIC has guaranteed to pay back (up to a point) if BofA blows it. Here’s what happened: people on the other side of BofA’s bets said, we’re not sure you’re good for the money, if it’s your gambling company on the hook for the losses (Merrill Lynch). So move the bets to your FDIC-insured company. Then we know the cash will be on hand to pay us off.

In this 10-18-11 Bloomberg article on how BofA’s move was supported by the Fed and opposed by the FDIC noted

“Three years after taxpayers rescued some of the biggest U.S. lenders, regulators are grappling with how to protect FDIC- insured bank accounts from risks generated by investment-banking operations.”

That is, “Three years after taxpayers rescued some of the biggest U.S. lenders, regulators are grappling with” how to re-invent the Glass-Steagall wheel. Why should they have to re-invent that wheel anyway? Oh, right, the banking lobby.

Big Dumb Rules Needed

As Felix Salmon pointed out, and highlighted by David Dayen, society needs big dumb rules as the foundation of modern finance. With the right boundaries set, a complex financial system can flourish. Glass-Steagall is a great example of a big dumb rule.

Big dumb rules are cruel at the margins. In law, that’s why judges will sometimes eschew “bright line rules” for the more discretionary “balancing tests”, which create less uniformity but can be used to minimize socially unjust outcomes. In finance that marginal unfairness is hated because it’s expensive. As Salmon says, “traders hate dumb rules, because they cap the amount of money they can make.”

To be clear, Salmon’s not advocating Glass-Steagall in his piece; here are the big dumb rules he’s talking about:

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.

Very sensible stuff. Salmonesque rules would compliment Glass-Steagall nicely, because his rules are aimed at the trades themselves, reining them in directly.

Besides cruelty at the margins, another hallmark of big dumb rules is that they’re easy to enforce uniformly. Wrongdoing is obvious. What a change restoring big dumb rules would make! We still don’t know for sure what cost Jamie Dimon so much money. That’s shocking, as our whole financial system cratered on opaque risks, as FT Alphaville pointed out.

Take Back the Power

Because Jamie Dimon has been the public face of the Wall Street effort to keep the cash spigot wide and the accountability for its use narrow, it’s worth revisiting the definitive history The House of Morgan, published in 1990 by Ron Chernow. Here are excerpts from the New York Times review of the book, bold mine. Try reading just the bold first, and remember this was written in 1990, 22 years ago:

A second refrain is the seesaw of power between Wall Street and Washington. In the early 1900’s the moneymen overwhelmingly controlled the national economy. Later they were reined in …But is Wall Street once again beyond control? After all, Congress has been groaning about stock market volatility, and it is horrified by the wave of debt-creating leveraged buyouts. Yet the lawmakers seem helpless to do much about these issues….

And when considering this next bit, you could insert “Goldman” for Morgan in the first sentence for variety’s sake:

Certainly, Mr. Chernow believes that the Morgan firms have become like their competitors - predatory bankers with little concern for anything but the bottom line – only much better at the game. He concludes that they have squandered their former reputation of being unswervingly loyal financiers to the world’s most respected companies. But he seems ambivalent about whether this could have been avoided in the modern era, dominated as it is by deregulated markets and ferocious competition.

Let it sink in: 22 years ago a serious look at financiers in America worried that their potentially devastating destructive power had become dangerously un-leashed. In those 22 years, the pendulum has only continued to swing toward the bankers. The pendulum got so far, in fact, that after blowing up the global financial system, the banking lobby prevented the restoration of a crucial big dumb rule and neutered its lobbying compromise.

Rather than stay caught in the briar patch debating “the Volcker rule” with the likes of Brer Jamie Rabbit Dimon, let’s climb out and look at the whole forest of modern finance again. Let’s put big dumb rules back in place, starting with Glass-Steagal and Salmon’s suggestions. Let’s save ourselves from the greed of the financial services industry, and save the industry in the process.


Many want to dismiss the idea of restoring Glass-Steagall as pie in the sky naivety, ignorant of the way the world now works and implying that the world must continue to work that way. I’m sure many said similar things about breaking up Standard Oil, or US Steel, or Ma Bell… Heck, those were only monopolies, relatively inefficient extracters of unjustified profit compared to the Fed subsidized gambling addicts of today…We shouldn’t worry about these banks’ failing before we confront them. If we could undo monopolies on economic grounds, surely we can undo today’s monstrosities.


Leave Your Comment

Your email will not be published or shared. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>