News, Regulation

Volcker Rule To End With “P.S. Please Don’t Blow Yourself Up”

The draft Volcker Rule proposal memo that American Banker got its hands on and published today is a pretty impressive piece of work. As a reminder, people thought that a reason 2008 was so unpleasant was that banks engaged in too much risky proprietary trading. So the testudinal gentleman to the right suggested, and Congress passed, a rule to rein in risk by banning FDIC-insured banks from proprietary trading.

But that’s hard to do, since the basic securities functions of a bank – making markets for customers, and hedging risks in its market-making book or in its regular old deposits-and-loans banking activities – require trading for its own account. So the agencies implementing the rule came up with a rule proposal that sets out, in 200 pages with lots of Q&A in case you have better ideas, to figure out how to distinguish bad “proprietary trading” from good “permitted trading.”

On a first read, er, skim, it’s really smart. It looks at a bunch of different metrics to distinguish market making from prop trading, like:

– Are you actually making two-sided markets, seeing two-sided flow, etc.?
– Are you accumulating more inventory than you could possibly find a use for?
– Are you making more money from commissions/fees/spreads or from inventory appreciation?
– Are you paying people based on commissions/fees/spreads or on inventory appreciation?
– Other stuff. Really, just so much other stuff.

Here’s my favorite part, from pages 106-107 if you’re following along at home. To set the scene, the rule bans “proprietary trading,” which is defined as short-term trading by a bank as principal. But that ban does not apply to “permitted trading activities,” which include market-making and hedging. *But*, certain kinds of “permitted trading activities” go back to being not permitted, including trading activities that raise “material conflicts of interest” (“you sold me a security that was designed to fail!”) or that expose the bank to “a high-risk asset or a high-risk trading strategy.” Got that? Okay, now:

Section __.8(c) of the proposed rule defines “high-risk asset” and “high-risk trading strategy” for proposes of § __.8’s proposed limitations on permitted trading activities. Section __.8(c)(1) defines a “high-risk asset” as an asset or group of assets that would, if held by the banking entity, significantly increase the likelihood that the banking entity would incur a substantial financial loss or would fail. Section __.8(c)(2) defines a “high-risk trading strategy” as a trading strategy that would, if engaged in by the banking entity, significantly increase the likelihood that the banking entity would incur a substantial financial loss or would fail.

A footnote says that banks should have a way to figure out what is a high-risk activity, and waves at “significant embedded leverage” as maybe an indicator.

Well okay. The thought process is:
– Prop trading is risky
– Let’s ban prop trading
– Here, in 200 pages of overlapping qualitative and quantitative factors, is a comprehensive definition of prop trading
– But we may have missed something that causes risk
– So let’s also ban anything else that is risky
– And you figure out if it’s risky or not

That’s cheating! You had 200 pages to define everything that you thought was risky, why do you need to include this extra “don’t do anything else risky either” rule? Or, put another way: if you’re going to have a rule saying “don’t do anything risky,” why do you need the other 200 pages?

It would be nice to think that regulators can figure out how to keep banks from losing money, write it all down – even if it takes 200 pages – and leave it to banks to carry out. Of course, it would be surprising if that were the case: if anyone has the incentives and expertise to keep banks from losing money, it would be banks – and so far their performance has been so-so. The mammoth draft Volcker Rule is an impressive effort to understand and specify the distinction, hard to draw precisely, between proprietary and market-making-and-hedging activities. But if you want to know whether all this careful definitional work will prevent another bank meltdown or financial crisis, the fact that the regulators felt the need to add “and don’t do anything else risky either” at the end is not all that hopeful a sign.

Cheat Sheet: Details of the Long-Awaited Volcker Rule [AB]

(hidden for your protection)
Show all comments

63 Responses to “Volcker Rule To End With “P.S. Please Don’t Blow Yourself Up””

  1. Backdoor_Bess says:

    If I could blow myself up, well, I would never leave the house.

  2. Pierce Inverarity says:

    Call me crazy, but, how about, I dunno, just reinstating Glass-Steagall so federally insured banks can't engage in investment banking at all?

    • Guest says:

      You're crazy….Thats logical AND makes sense. How could these 'tards figure something like that out

    • Texashedge says:

      It certainly would save a lot of W.A.S.T.E.d paper, wouldn't it Pierce?

    • Guest says:

      You are aware that BSC, LEH, and MER were never banks, and while during 2008 GS and MS became bank holding companies in order to have access to the Fed window they did not and still do not have any FDIC-insured deposits? You are further aware that had Glass-Steagall been in effect, JPM would not have been able to buy BSC, BAC would not have been able to buy MER, and LEH would have had to liquidate everything because Barclays wouldn't have been allowed to buy its operations out of bankruptcy (well, perhaps Barclays could have still have bought it- I forget what Glass-Steagall had to say about foreign banks with foreign deposits)? Not only would Glass-Steagall completely failed to prevent the crisis, it would have made it vastly worse. It was in effect during the LTCM mess and had no part in preventing a very near meltdown. It was in effect during the S&L crisis and there still had to be a big federal bailout.

      Please explain how Glass-Steagall would do anything useful

      • Phyllis Dean says:

        Yes they have FDIC insured deposits, just very very few. To be a BHC you must own a bank, to be a bank you must accept deposits and make loans.


      • Spanishmoon says:

        Wrong. Merrill Lynch owned a very large bank before BAC took it over. Look it up.

        MS has a bank today with insured deposits. Before they spun off Discover, it had a very large bank. I have money in MS's bank today. Otherwise their big retail customers would have bailed out long ago.

        You analysis is post hoc, ergo propter hoc. Flawed logic. None of the SIVs, derivatives, MBS conduits etc. ever would have existed on the balance sheets of commercial banks under G-S.

        Investment banks have been blowing up since the beginning of finance. Civilization continued.

        Putting G-S back on the books will get these idiot banks out of trading and make the system safer. Otherwise, we are all going to lose our jobs when one of these big banks blows itself up and the OWS people bring guns to the next protest.

      • Pierce Inverarity says:

        Non sequitur. You're arguing something not on the board.

        The issue at hand is this: instead of initiating innumerable new regulations and the unforeseen consequences (and loopholes) that result, why not merely default back to a clean, simple rule that worked fairly well for 66 years.

  3. IgnorantBastards says:

    what is he looking for behind his head?

  4. Milksteak says:

    I don't have a problem with the end sentence, it's kind of like the caveat I give to people (girls) regarding attending events I don't feel like going to.

    "yeah, I'll definitely try to make it, probably." Vague and non-committal, that's the name of the game.

  5. PermaGuestII says:

    At least the Adminstration came up with a way to employ all those out-of-work law school grads.

  6. Alt_EST says:

    I just blue myself.

    -T Funke

  7. UBS ETF Trader says:

    Wait… what's a hedge?

  8. K.Adoboli says:

    I was sorta under the impression that it was the government's responsibility to prevent banks from failing while we invent new ways to blow them up … ____Good thing that's all cleared up now.

  9. jumbo says:

    Telling banks not to do anything "risky", then failing to define what is risky creates a legal loophole big enough to rival the hole in Morgan Stanley's balance sheet.

    Good luck to the government regulators/litigators who have to prove in court that a bank was knowingly undertaking risky behavior in violation of the rule … you know, unless the bankers are stupid enough to write emails about how shitty some of the deals are.

  10. Jay says:

    Why was he looking at me when he proposed it?

    – Kweku

  11. Spanishmoon says:


    Back when you were in diapers, we old-timers worked at places called "investment banks". We took risks with partner capital, not depositors' funds. Banks handed out toasters to depositors. We traded.

    You can't be half pregnant or half-subsidized.

    Few of you kids are going to have jobs on the Street if we don't get these asshole, incompetent banks out of the business before they destroy it for the rest of us.

    Sorry. End of sermon.

  12. MeVC says:

    When not busy writing rules, Mr. Volcker films commercials for Six Flags Entertainment Group as the Mr. Six character.

  13. TOF says:


  14. DKWC says:

    "I'm sorry regulator, I didn't know I couldn't do that"

    -Because I DID know I couldn't that!

  15. jxJqsM I really like and appreciate your blog article. Really Great.

  16. Muchos Gracias for your post.Thanks Again. Much obliged.

  17. Thank you ever so for you article.Thanks Again. Great.

  18. Really informative article.Really thank you! Awesome.

  19. california says:

    Looking forward to reading more. Great blog article.Really looking forward to read more.

  20. odżywki says:

    I value the blog article.Really looking forward to read more.

  21. Wow, great article post.Really thank you! Really Great.

  22. Enjoyed every bit of your blog.Thanks Again. Really Cool.

  23. Im obliged for the blog.Really looking forward to read more. Cool.

  24. Thanks for the article.Much thanks again. Great.

  25. SEO New York says:

    Great blog post.Thanks Again.

  26. Great article. Will read on…

  27. I loved your blog article.Really thank you! Cool.

  28. Enjoyed every bit of your blog.

  29. Thank you for your blog post. Much obliged.

  30. wow, awesome blog article.Really thank you! Want more.

  31. This is one awesome article post.Really looking forward to read more.

  32. Thank you for your article.Much thanks again. Want more.

  33. Great, thanks for sharing this article.Really thank you! Much obliged.

  34. Say, you got a nice blog article.Much thanks again. Awesome.

  35. Fantastic article.Thanks Again. Will read on…

  36. vibrator says:

    Thanks again for the article.Really thank you! Really Great.

  37. Gameplay says:

    Im grateful for the blog.Much thanks again. Much obliged.

  38. fantasy arts says:

    I truly appreciate this blog.Much thanks again. Cool.

  39. uk swingers says:

    I loved your article post.Thanks Again. Keep writing.

  40. Really informative blog post. Fantastic.

  41. 2 says:

    Great blog article. Will read on…

  42. Major thanks for the blog. Awesome.

  43. Thanks for the blog.Really thank you! Really Great.

  44. A round of applause for your article.Really thank you! Really Great.

  45. Traffic says:

    Fantastic blog post.Really looking forward to read more. Fantastic.

  46. I really liked your article post.Thanks Again. Want more.

  47. hid bulb says:

    This is one awesome article.Much thanks again. Fantastic.

  48. Great article.Thanks Again. Fantastic.

  49. I value the blog.Thanks Again. Really Great.

  50. I value the post.Really thank you! Really Cool.

  51. gay porn says:

    Im obliged for the post.Really thank you!

  52. Im grateful for the blog post.Really looking forward to read more. Will read on…

  53. bigcat says:

    Spot on with this write-up, I truly assume this website wants way more consideration. I’ll most likely be again to learn much more, thanks for that info.

  54. PeLqDa Hey, thanks for the blog article.Really looking forward to read more.

  55. Is definitely the whole JMU video game obtainable wherever on line? WVUgames doens’t have it up nonetheless on their YouTube channel. Slacker.