Did Obama’s economists do their homework on the Volcker rule?02/3/2010 by Jeff Madrick
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What is disturbing is how poorly the Volcker rule has been thought through. When first announced, it sounded like a worthy and needed step in the right direction, and a suggestion the Obama team was waking up to reality. But I also expected more sophisticated details to come.
So far, there are none. The main proposal is to separate “proprietary” trading from lower-risk normal bank activities. I naturally assumed the Obama team was going to expand the definition of proprietary trading beyond its narrow meaning on Wall Street. So far it looks like they didn’t give it much thought before announcing the plan. This is a critical error in judgment.
Volcker apparently thinks that proprietary trading encompasses most of the risk-taking speculation done by the banks. He objects, because they put at risk the money that is guaranteed by the federal government. The banks have access to the Fed window for reserves to bail them out, and trillions of dollars of federally-insured checking and savings savings deposits.
It is hard to imagine he is that out of touch. Disturbingly, Volcker has said publicly that most bankers know the difference between trading for speculation and trading for their customers (making markets). Well, if they do, how do we truly separate the two tasks? It is a lot harder than it looks.
When the banks make markets through their sophisticated trading desks, they often take positions in securities, including in the past collateralized debt obligations and all manner of derivatives, including credit default swaps. They also borrow in the short-term loan markets to do that.
They take so-called directional positions as well. If they think interest rates will fall, they may buy more bonds on the trading desk — and undertake far more complex versions of that same strategy. How much of this goes on? A couple of journalistic pieces quoting bankers claimed not much. Don’t believe a word of that......
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