Posts Tagged ‘Volcker Rule’

JP Morgan Chase’s $2 Billion Loss Under Investigation

Monday, May 21st, 2012

As the Department of Justice and the FBI open their investigation into how JP Morgan Chase lost $2 billion, the government is investigating to determine if any criminal wrongdoing occurred.  The inquiry is in the preliminary stages.  Additionally, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC), which regulates derivatives trading, are also looking into JPMorgan’s trading activities.  JPMorgan CEO Jamie Dimon said that the bank made “egregious” mistakes and that the losses tied to synthetic credit securities were “self-inflicted.”

The probe is perceived as necessary, given the ongoing debate about bank regulation and reform, and one expert said it raised the level of concern around what happened.  “The FBI looks for evidence of crimes and goes after people who it alleges are criminals.  They want to send people to jail.  The SEC pursues all sorts of wrongdoing, imposes fines and is half as scary as the FBI,” said Erik Gordon, a professor in the law and business schools at the University of Michigan.

According to Treasury Secretary Timothy Geithner, the trading loss “helps make the case” for tougher rules on financial institutions, as regulators implement the Dodd-Frank law aimed at reining in Wall Street.  Geithner said the Federal Reserve, the SEC and the Obama administration are “going to take a very careful look” at the JPMorgan incident as they implement new regulations like the “Volcker Rule,” which bans banks from making bets with customers’ money.  “The Fed and the SEC and the other regulators — and we’ll be part of this process — are going to take a very careful look at this incident and make sure that we review the implications of what that means for the design of these remaining rules,” Geithner said.  Under review will be “not just the Volker Rule, which is important in this context, but the broader set of safeguards and reforms,” Geithner said, noting that regulators will also scrutinize capital requirements, limits on leverage and derivatives markets reforms.  “I’m very confident that we’re going to be able to make sure those come out as tough and effective as they need to be,” Geithner said.  “And I think this episode helps make the case, frankly.”

Geithner said that Dodd-Frank wasn’t intended “to prevent the unpreventable in terms of mistakes in judgment, but to make sure when those mistakes happen — and they’re inevitable — that they’re modest enough in size, and the system as a whole can handle them.”  The loss “points out how important it is that these reforms are strong enough and effective enough,” he said.

With the passage of Dodd-Frank, banks are required to hold more capital, reduce their leverage and assure better cushions across the financial system to accommodate losses.  Geithner’s comments are similar to those made by other White House officials, who have avoided blasting the bank for its bad judgment, and instead used the event to bolster the case for the financial overhaul.

“We are aware of the matter and are looking into it,” a Justice Department official said “This is a preliminary look at what if anything might have taken place.”  The inquiry by the FBI’s financial crimes squad is in a “preliminary infancy stage,” the official said, and federal law enforcement agents are pursuing the matter “because of the company and the dollar amounts involved here.”

JPMorgan’s and the financial system’s ability to survive a loss that large showed that reforms put in place after the 2008 financial crisis have succeeded.  Nevertheless, the loss by the nation’s largest bank highlights the need for tough implementation of the Volcker Rule on proprietary trading and other rules that regulators are still finalizing.  “The whole point was, even if you’re smart, you can make mistakes, and since these banks are insured backed up by taxpayers, we don’t want you taking risks where eventually we might end up having to bail you out again, because we’ve done that, been there, didn’t like it,” according to President Obama.

Mark A. Calabria, Director of Financial Regulation Studies for the Cato Institute, takes a contrarian view.  Writing in the Huffington Post, Calabria says that “Unsurprisingly, President Obama and others have used the recent $2 billion loss by JPMorgan Chase as a call for more regulation. Obviously, our existing regulations have worked so well that more can only be better!  What the president and his allies miss is that recent events at JPMorgan illustrate how the system should — and does — work.  The losses at JPMorgan were borne not by the American taxpayer, but by JPMorgan.  The losses also appear to have been offset by gains so that in the last quarter JPMorgan still turned a profit.  This is the way the system should work.  Those who take the risk, take the loss (or gain).  It is a far better alignment of incentives than allowing Washington to gamble trillions, leaving someone else holding the bag.  The losses at JPMorgan have also resulted in the quick dismissal of the responsible employees.  Show me the list of regulators who lost their jobs, despite the massive regulatory failures that occurred before and during the crisis.

According to Calabria, “President Obama has warned that ‘you could have a bank that isn’t as strong, isn’t as profitable making those same bets and we might have had to step in.’  Had to step in?  What the recent JPMorgan losses actually prove is that a major investment bank can take billions of losses, and the financial system continues to function even without an injection of taxpayer dollars.  It is no accident that many of those now advocating more regulation are the same people who advocated the bailouts.  Banks need to be allowed to take losses.  The president also sets up a ridiculous standard of error-free financial markets.  All human institutions, including banks and even the White House, are characterized by error and mistake.  Zero mistakes is an unattainable goal in any system in which human beings are involved.  What we need is not a system free of errors, but one that is robust enough to withstand them.  And the truth is that the more small errors we have, the fewer big errors we will have.  I am far more concerned over long periods of calm and profit than I am with periods of loss.  The recent JPMorgan losses remind market participants that risk is omnipresent.  It encourages due diligence on the part of investors and other market participants, something that was sorely lacking before the crisis.”

CFTC Gives Tentative Green Light to Volcker Rule

Wednesday, February 1st, 2012

The federal Commodity Futures Trading Commission (CFTC) proposed limiting banks’  proprietary trading and hedge fund investments under the Dodd-Frank Act’s Volcker rule. The CFTC  3-2 vote makes it the last of five regulators to seek public comment on the proposal. This vote opens the measure to 60 days of public comment.  The rule, named for former Federal Reserve Chairman Paul Volcker, was included in Dodd-Frank to rein in risky trading at banks that benefit from federal deposit insurance and Fed discount window borrowing privileges.

The CFTC stayed mum when the Fed, Federal Deposit Insurance Corporation, Securities and Exchange Commission and Office of Comptroller of the Currency released their joint proposal last year. The four agencies extended the comment period on their proposal until February 13 after financial-industry groups and lawmakers cited the complexity of the rule and the lack of coordination with the CFTC in requesting an extension.

The CFTC may soften Dodd-Frank a bit, granting Wall Street banks exceptions to rules requiring dealers to sensibly believe their derivatives are suitable for clients and in the best interests of endowments and other so-called special entities.  The rules “implement requirements for swap dealers and major swap participants to deal fairly with customers, provide balanced communications, and disclose material risks, conflicts of interest and material incentives before entering into a swap,” CFTC Chairman Gary Gensler said.

Opponents say the CFTC proposal would cause “severe market disruption” by transforming the relationship between swap dealers and clients such as pensions and municipalities, according to Sifma and the International Swaps and Derivatives Association, Inc.. Under the final rule, dealers must disclose material risks and daily mid-market values of contracts to their clients. The CFTC may also complete rules designed to protect swap traders’ collateral that is used to reduce risk in trades. The rule insulates the collateral if the broker defaults, while allowing the customer funds to be pooled before a bankruptcy, according to a CFTC summary of the regulation.

Commissioner Scott O’Malia voted in favor or the rule, but said he did not want to give market participants “a misleading sense of comfort” that it would have prevented the loss of customer money at the brokerage giant.  “This rulemaking does not address MF Global,” O’Malia said. “This rulemaking would not have prevented a shortfall in the customer funds of the ranchers and farmers that transact daily in the futures market. Nor would it have expedited the transfer of positions and collateral belonging to such customers in the event of a collapse similar to that of MF Global.”

Commissioner Jill Sommers, who voted against the rule, criticized the rule for doing nothing to protect a futures commission merchant’s futures customers.  “Given recent events, we need to re-think this approach so we can provide adequate protections, in a comprehensive and coherent way, to swaps customers and to futures customers,” Sommers said. “I do not favor a piecemeal approach to customer protection.”

Federal Reserve Asks for Comments Before Implementing the Volcker Rule

Monday, October 24th, 2011

Federal regulators have requested public comment on the Volcker Rule — the Dodd-Frank Act restrictions that would ban American banks from making short-term trades of financial instruments for their own accounts and prevent them from owning or sponsoring hedge funds and private-equity funds.  The Volcker rule, released by the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC) and Office of the Comptroller of the Currency, is intended to head off the risk-taking that caused the 2008 financial crisis.  The rule, which is little changed from drafts that have been leaked recently, would ban banks from taking positions held for 60 days or less, exempt certain market-making activities, change the way traders involved in market-making are compensated and assure that senior bank executives are responsible for compliance.

Analysts say the proposed rule could slash revenue and cut market liquidity in the name of limiting risk.  Banks such as JPMorgan Chase & Co. and Goldman Sachs Group Inc., have already been winding down their proprietary trading desks in anticipation of the Volcker Rule kicking in.  Banks’ fixed-income desks could see their revenues decline as much as 25 percent under provisions included in a draft, brokerage analyst Brad Hintz said.  Moody’s Investors Service said the rule would be “credit negative” for bondholders of Bank of America Corporation, Citigroup, Inc., Goldman Sachs, JPMorgan and Morgan Stanley, “all of which have substantial market-making operations.”  The rule, named for former Federal Reserve Chairman Paul Volcker, was included in the 2010 Dodd-Frank Act with the intention of reining in risky trading by firms whose customer deposits are insured by the federal government.

John Walsh, a FDIC board member and head of the Office of the Comptroller of the Currency, said that he was “delighted” that regulators had reached an agreement on the proposed rule, “given the controversy that has surrounded this provision — how it addressed root causes of the financial crisis.”  “I expect the agencies will move in a careful and deliberative manner in the development of this important rule, and I look forward to the extensive public comments that I’m sure will follow,” Martin J. Gruenberg, the FDIC’s acting chairman, said.  The rule will be open for public comment until January.

Not surprisingly, Wall Street opposes the rule, saying it will cut profits and limit liquidity at a difficult time for the banking industry.  Moody’s echoed those concerns, saying the current version of the Volcker rule would “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.”  Some Democratic lawmakers and consumer advocates are pushing to close loopholes in the rules, especially the broad exemption for hedging.  Supporters of the Volcker rule take issue with a plan to excuse hedging tied to “anticipatory” risk, rather than clear-and-present problems.  “Unfortunately, this initial proposal does not deliver on the promise of the Volcker Rule or the requirements of the statute,” said Marcus Stanley, policy director of Americans for Financial Reform, an advocacy group.  Additionally, the Securities Industry and Financial Markets Association raised concerns about whether the exemption for trades intended to make markets for customers is too narrow.

According to Moody’s, the large financial firms all have “substantial market-making operations,” which the Volcker Rule will target.  The regulations also will recreate compensation guidelines so pay doesn’t encourage big risk-taking.  Derivatives lawyer Sherri Venokur said restrictions on compensation are “intended to create a sea change in the mindsets of those who create the culture of our banking institutions — to value ‘safety and soundness’ as well as profitability.”

Equity analysts at Bernstein say that the Volcker Rule — if implemented in its current form – will slash Wall Street brokers’ revenues by 25 percent, and cut pre-tax margin of their fixed income trading businesses by 33 percent.  According to Bernstein, the Volcker Rule’s potential limitations are a surprise because it appears to prohibit flow trading in “nonexempt portions” of the bond-trading business.  Bernstein says inventory levels – and, in all probability, risk taking – must be based on client demands and not on “expectation of future price appreciation.”

A Bloomberg.com editorial offers support to the Volcker Rule, while admitting it won’t be perfect.  According to the editorial, “This week, the first of several regulatory agencies will consider a measure aimed at ending the practice.  Known as the Volcker rule, after Paul Volcker, the former Federal Reserve chairman, the measure would curb federally insured banks’ ability to make speculative bets on securities, derivatives or other financial instruments for their own profit — the kind of ‘proprietary’ trading that can lead to catastrophic losses.  Whatever form it takes will be far from perfect.  It will also be better than the status quo.  The bank bailouts of 2008, and the public outrage over traders’ and executives’ bonuses, laid bare a fundamental problem in big institutions such as Bank of America Corporation, Citigroup Inc. and JPMorgan Chase & Co.

“They attempt to combine two very different kinds of financial professionals: those who process payments, collect peoples’ deposits and make loans, and those who specialize in making big, risky bets with other peoples’ money.  When these big banks run into trouble, government officials face a dilemma. They want — and in some ways are obligated — to save the part of the bank that does the processing and lending, because those elements are crucial to the normal functioning of the economy.  But in doing so, they also end up bailing out the gamblers, a necessity that erodes public support for bailouts and stirs enmity for banks.  Separating the bankers from the gamblers is no easy task. Commercial banks’ explicit federal backing — including deposit insurance and access to emergency funds from the Federal Reserve — is attractive to proprietary traders, who can use a commercial bank’s access to cheap money to boost profits.  Bank executives like to employ traders because they generate juicy returns in good times that drive up the share price and justify large bonuses. In effect, both traders and managers are reaping the benefits of a government subsidy on financial speculation.  The Volcker rule will not — and probably cannot — fully dissolve the union of bankers and gamblers.”

How Did a Rogue UBS Trader Lose $2 Billion?

Tuesday, October 18th, 2011

The strange saga of how a rogue UBS trader lost $2 billion and who has since been fired and charged with fraud and false accounting in a London court has raised questions about the bank’s stability and whether it will retain its clients.  Ghana-born trader Kweku Adoboli was perceived as a polite and snappily dressed young man who mixed grueling hours in London’s financial district with a lavish social life in the capital’s nightspots.  But even the 31-year-old Adoboli appeared to foresee his work-hard, play-hard lifestyle coming undone.  “Need a miracle,” he posted on his Facebook page, just hours before his arrest.

Analysts and regulators questioned why the Swiss banking giant UBS and its monitoring systems had failed to spot Adoboli’s alleged fraud.  “Nobody blames the tiger for stalking its prey, but you do blame the zookeeper for leaving the tiger’s cage open,” said Stephen Brown, professor of finance at New York University’s Stern School of Business.  “These top banks hire the best and brightest ambitious young people and when they outperform everyone else the bankers want to believe in their brilliance so they look the other way.  That’s exactly what happened at UBS.”

Said a London based private banker at a rival global institution, “We don’t want to gloat because there but for the grace of God.  But it’s likely to be the kind of thing that if we were in competition with them for a pitch it would help us because it would be another question mark in people’s minds,” he said. 

Peter Thorne, an analyst at Helvea said this crisis is less serious than UBS’ previous woes and is unlikely to result in a similar stampede.  “I can’t believe they’re not going to do their utmost to maintain their clients. Also, if you’ve been through the financial crisis and you stuck with UBS you must love them, so I’m not sure you’re going to jump ship,” he said.

The Wall Street Journal’s David Weidner compares this case to that of Nick Leeson.  “Consider the story of Nick Leeson, the first trader to bring down a bank.  He racked up $1 billion in losses and was sentenced to six years in jail.  Barings Bank collapsed under the weight of the exposure.  Leeson said exceptional risk-taking was common.  He actually used an account that his team had set up to cover losses of a junior trader.  And as many accused rogues have argued, Leeson said the bank tacitly approved.  The number of rogue traders — there have been at least 11 since 1995 who have lost roughly $10 billion combined – suggests that Leeson may be right.  So, why is trading beyond internal limits allowed?  Because of the winners.  Enter Philipp Meyer, a former UBS derivatives trader who left the business a few years ago and wrote about the excess of the business.  To be clear, Meyer never said he made unauthorized trades, but he did offer this observation about trading.  ‘It was pretty clear what The Market didn’t like.  It didn’t like being closely watched. It didn’t like rules that governed its behavior.’”

Writing for Business Week, William D. Cohan says that “Whether UBS is shown to have been aware of Adoboli’s trading is almost beside the point.  If the bank was aware of it and did not stop it, then its failure to do so is unconscionable. If it was not aware of the trades, then its compliance and risk management departments’ failure to prevent them from happening in the first place is equally appalling.  In the post-Lehman, Dodd-Frank, Basel-III era, it is nearly unfathomable that a global bank of UBS’s heft, wealth and importance could allow this kind of loss to occur.  Where were the adults?  There will almost certainly be regulatory consequences for the rest of Wall Street as a result of this ill-timed debacle.  The banks will howl, but tighter rules could actually help protect the rest of us from their bad behavior.”

Happily for the United States and the Dodd-Frank laws, it’s less likely that a rogue trader could topple a major U.S. financial institution.  One section of the Dodd-Frank legislation is the Volcker Rule, named after former Federal Reserve chairman Paul Volcker, which limits American banks’ ability to trade their own funds.  That wasn’t true in 2008, when losses from bad bets that banks made on mortgages led to the meltdown of Bear Stearns and Lehman Brothers.  Full implementation of the Volcker Rule is expected to be delayed from its original July 21, 2012 deadline.  A majority of the largest American banks have already sold or closed the desks that make these trades – known as “prop” or proprietary trading desks.  “Banks can put themselves under with dangerous trading and take the commercial side with them as they go down,” said Robert Prentice, a professor of business law at the University of Texas’ McCoombs School of Business.  “A big part of what the Volcker Rule will do is separate out the risky trading from the deposits.”

A majority of the banking system depends on computers to spot abnormal trading activity that could signal unauthorized trades.  Industry watchers still question whether the Volcker Rule in its final form will mandate the spin-off of prop trading from banks or whether it will be watered down.  “You can’t underestimate the lobbying ability of the banking industry in the U.S. and the U.K.” said Stewart Hamilton, a finance and accounting professor at the University of Edinburgh.  “It’s huge.”

Volcker Rule Is Giving Big Banks Headaches

Wednesday, August 25th, 2010

Volcker Rule implementation is scaring the big banks.  Curiosity is growing about which Wall Street banks will be the first to get out of proprietary trading or the private equity business as they restructure to come into compliance with new financial regulatory reform legislation. The Volcker Rule – named for former Federal Reserve chairman Paul Volcker – limits banks from these practices and sets new levels on the size of private equity or hedge fund investments.  In other words, the banks are not allowed to hold more than three percent of their Tier 1 capital – a measure of their financial strength — in private equity or hedge fund investments.

Bank of America is almost in compliance, though Goldman Sachs must act more aggressively and is reported to be weighing several options to comply with the increased regulation.  The good news for the Wall Street banks is that they have several years in which they can reduce their holdings.  “They have time to adjust,” said Mark Nuccio, partner at Boston-based Ropes & Gray.  “I don’t think there’s any intention on behalf of the regulators to create economic dislocation at financial institutions.”

The new rules are driving certain banks to rethink their business, while others see the new law as a welcome excuse to distance themselves from unwanted hedge or private-equity funds.  “If you were leaning toward a strategic change anyway then now is a good time to re-evaluate the business because you have a regulator saying you shouldn’t be in this business anyway,” said Thomas Whelan, chief executive of Greenwich Alternative Investments.  This is particularly true for banks that quickly acquired hedge fund operations during the boom years.  At that time, having a hedge fund was essential to the strategic mix.  Since 2008, however, when hedge funds posted their worst-ever returns and clients tried to cash in assets, the math changed for many banks.

Financial Reform Legislation Faces Uphill Battle in the Senate

Wednesday, April 14th, 2010

The most sweeping financial reform legislation since the 1930s will be debated in a polarized Senate.  Senator Christopher Dodd (D-CT), chairman of the Senate Banking Committee, introduced revised legislation to regulate the nation’s financial system.  The plan would create a nine-member council, led by the Treasury secretary, to be on the alert for systemic risks, and direct the Federal Reserve to oversee the nation’s largest and most interconnected financial institutions.

The bill, which would be the most comprehensive change in financial rules since the Depression, would preserve much of the existing regulatory system, which has been criticized as being too disjointed.  Additionally, it would rely on a new mechanism for seizing and liquidating large financial companies on the verge of failure.  This would reduce, but not eliminate, the possibility of future bailouts.

The legislation incorporates a version of the Volcker Rule, a proposal from former Federal Reserve Chairman Paul Volcker that would make certain that legislators ban banks from investing in or owning hedge and private-equity funds.  Republicans and Wall Street strongly object to that idea.  Dodd’s legislation takes a fairly tough line with financial firms in general.  The proposed consumer protection agency would be given the authority to write and enforce rules for banks with more than $10 billion in assets.  The oversight also would apply to mortgage companies, credit card issues and other lenders – a move that Republicans oppose.

“Our regulatory structure, constructed in a piecemeal fashion over many decades, remains hopelessly inadequate,” Dodd, who is retiring from the Senate at the end of this term, said.  “There hasn’t been financial reform on the scale that I’m proposing this afternoon since the 1930s….  It is certainly time to act.”

Volcker Rule Seeks to Regulate Financial Markets

Wednesday, March 31st, 2010

President Obama’s proposed Volcker Rule financial regulation bill faces an uncertain future on Capitol Hill.  A draft of President Barack Obama’s financial reform legislation has been sent to Congress.  Dubbed the Volcker Rule in honor of the former Federal Reserve chairman’s  aggressive pursuit of these regulations, the five-page proposal will ban proprietary trading and mergers that give banks more than a 10 percent market share as measured by liabilities that are not insured deposits.  Passage of the bill would bar banks from owning or investing in private equity firms and hedge funds.

The rule, designed to reduce the possibility of another financial crisis, exempts mergers that exceed the market-share limit in instances where a firm takes over a failing bank so long as regulators approve.  Also exempted are trading in Treasury and agency securities, including debt issued by Ginnie Mae, Fannie Mae and Freddie Mac.

The legislation, which has been criticized by both Republicans and Democrats, would reduce banks’ ability to take risks.  It is a reaction to the more than $1.7 trillion in writedowns and credit losses that followed the subprime mortgage meltdown in late 2007.  Congressman Barney Frank (D-MA), chairman of the House Financial Services Committee, prefers a five-year transition period rather than the two years suggested in the president’s proposal.

Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York says the exemptions may help avoid market disruptions that could impact small investors.  “The market is made up of many unseen hands with different objectives and investment horizons, and if you pull out the speculators making short-term bets, like prop trading banks, then” the individual investor is “going to be the one who suffers.”