Volcker Rule Approved

The big banks who had been running wild since the days of the repealing of the Glass Steagall Act will now have to curb some of their excitement due to the Volcker Rule.

The rule was approved by all five regulatory agencies.

As President Obama said after the finalization of the rule:

The Volcker rule will make it illegal for firms to use government-insured money to make speculative bets that threaten the entire financial system, and demand a new era of accountability from CEOs who must sign off on their firm's practices.

Most big banks have already complied with the rules in anticipation of the approval.

Banks with $10 billion or less will be exempt from the rule if they don't engage in most activities covered by it.

A synopsis of the Volcker rule in the WSJ:

The Volcker rule, named after its proponent—former Fed Chairman Paul Volcker—will require banks to demonstrate ahead of time how their hedging strategies are designed to work, and formulate approval procedures for when they divert from those plans. The preamble to the rule says banks must ensure hedges are aimed at mitigating risks "at inception" and that they "should be based on analysis conducted by the banking entity of the appropriateness of hedging instruments, strategies, techniques and limits" as well as an "analysis of the correlation" between the hedge and its underlying risks.

The rule does include some wins for banks, including allowing firms to trade foreign sovereign debt, a shift from an earlier version of the rule that provided an exemption to the proprietary trading ban for U.S. Treasury securities but didn't mention foreign bonds.

Now let's see if the regulators have the stomach and the man power to police the situation.

Confessions of a Quantitative Easer

Interesting opinion piece by a gentleman named Andrew Huszar.  Mr. Huszar is a former Fed official who was actually responsible for the $1.25 trillion dollar QE bond buying that occurred in 2009.

As Mr. Huszar states in his piece:

My part of the story began a few months later. Having been at the Fed for seven years, until early 2008, I was working on Wall Street in spring 2009 when I got an unexpected phone call. Would I come back to work on the Fed's trading floor? The job: managing what was at the heart of QE's bond-buying spree—a wild attempt to buy $1.25 trillion in mortgage bonds in 12 months. Incredibly, the Fed was calling to ask if I wanted to quarterback the largest economic stimulus in U.S. history.

 This was a dream job, but I hesitated. And it wasn't just nervousness about taking on such responsibility. I had left the Fed out of frustration, having witnessed the institution deferring more and more to Wall Street. Independence is at the heart of any central bank's credibility, and I had come to believe that the Fed's independence was eroding. Senior Fed officials, though, were publicly acknowledging mistakes and several of those officials emphasized to me how committed they were to a major Wall Street revamp. I could also see that they desperately needed reinforcements. I took a leap of faith.

It didn't take long for Mr. Huszar to see that nothing changed as he states:

 It wasn't long before my old doubts resurfaced. Despite the Fed's rhetoric, my program wasn't helping to make credit any more accessible for the average American. The banks were only issuing fewer and fewer loans. More insidiously, whatever credit they were extending wasn't getting much cheaper. QE may have been driving down the wholesale cost for banks to make loans, but Wall Street was pocketing most of the extra cash.

As for the results:

 And the impact? Even by the Fed's sunniest calculations, aggressive QE over five years has generated only a few percentage points of U.S. growth. By contrast, experts outside the Fed, such as Mohammed El Erian at the Pimco investment firm, suggest that the Fed may have created and spent over $4 trillion for a total return of as little as 0.25% of GDP (i.e., a mere $40 billion bump in U.S. economic output). Both of those estimates indicate that QE isn't really working.

The most interesting part of the article is towards the end of the piece where he states:

 As for the rest of America, good luck. Because QE was relentlessly pumping money into the financial markets during the past five years, it killed the urgency for Washington to confront a real crisis: that of a structurally unsound U.S. economy. Yes, those financial markets have rallied spectacularly, breathing much-needed life back into 401(k)s, but for how long? Experts like Larry Fink at the BlackRock investment firm are suggesting that conditions are again "bubble-like." Meanwhile, the country remains overly dependent on Wall Street to drive economic growth.

I for one am still on the fence trying to figure out which side of the argument is valid.  Did QE help our economy or  has it put us in quite a bind right now.  My suspicion is that it could be a bit of both.  there is no question in my mind that as rates bumped against the zero lower bound the Fed was forced to try something a lot more exotic in order to try to help the economy.  Many people say that the best thing the Fed could have done would have been to significantly increase inflation rate targets in order to show that the Fed would not be getting in the way of a recovering economy even if it hit that 2% target but since that wasn't on the table QE was a valid option.

The big problems with QE are threefold:

1. Since the big winners in the QE extravaganza are the banks that caused this mess in the first place has the Fed placed it's credibility in doubt with the general public?
2. Will the Fed be able to time the "taper" correctly and allow market forces the necessary time to adjust?
3. How ugly will the market adjustment be when the Fed tries to mop up the liquidity?

All good questions.  I keep searching for answers.

Another Case of the Patients Running the Assylum

European banks are looking for ways to modify their risk adjusted weightings of assets on their balance sheets in order to fill the capital requirements imposed on them by the latest European agreement.

Apparently they don't want to reduce bonuses and wages and they know it won't be easy to raise capital in financial markets given the circumstances so they again are turning to creative accounting to right the shortfall.  This falls in the same category as FASB allowing banks to "relax" mark to market accounting.  Neither of these issues, although legal, will actually allow investors to get a clear picture of what is going on in a bank balance sheet.

Bloomberg article here.

IIF on European Bank Recapitalization

Charles Dallara who is Managing Director of the International Institute of Finance said the following in a letter he submitted to G20 leaders before the start of the meetings in Cannes tomorrow and Friday.

“It is essential for the official sector to begin viewing the banking system as an indispensible partner in fostering recovery, rather than an adversary on which it is necessary to impose ever more punitive measures.” 

Interesting how the banks who are again on the brink of failure again are going against an increase in capital requirements which will help keep banks solvent and depositors safe.

Read Bloomberg story here.

To All Who Knock Regulation

For everyone who claims that regulation of Wall Street is not necessary.  That in a capitalistic society, the market is the regulator.  Please allow me to introduce MF Global, impersonating Lehman Brothers.  I think I've seen this movie before?!?!

Huntsman's Attack on Too Big to Fail Banks

Simon Johnson's entry in the Economix blog states that John Huntsman is one of the few Republican candidates that is taking a position against big banks.

I don't agree with many of the right's beliefs but this is something we can all agree on.

Banks are too big.  The implicit backstop that they have from the government because of their size allows these banks to take on way too much risk.  As stated yesterday, Goldman reported a $2.5B investment loss.  This is a company that is now chartered as a bank, that has received bailout money as a bank and is now back to recording enormous losses in its own trading accounts.  Whether you lean to the right or to the left, I think we can all agree that this needs to stop.  Maybe Glass Steagall wasn't so bad after all.

Question on Goldman and all Banks

As Goldman reported a $2.5B loss on it's investments one has to wonder why the hell are banks that are backstopped by the US government allowed to invest their own money?  What makes these departments of banks any different than hedge funds and private equity shops?  This questions was posed in wsj's Heard on the Street (subscription required).