|By JESSE EISINGER|
The path to gaming the Volcker Rule has always been clear: Banks will shut down anything with the word "proprietary" on the door and simply move the activities down the hall.
To look like they were ready to comply with the Volcker Rule, the part of the Dodd-Frank Act that aims to prevent banks from gambling on their own account with money that taxpayers insure, financial firms quickly spun off or shut down their hedge funds, private equity firms and proprietary trading desks.
But the suspicious-minded among us wonder whether it was all that simple. This is the specter raised by the news that a
The Congressional authors of the Volcker Rule worried about this very thing, and you can trace their concerns through their drafts. The original language of the rule had a broad exception: banks couldn't trade for their own account, but they could hedge to mitigate their risks.
The authors quickly realized that the exemption was absurdly broad. After moving these businesses to other divisions, banks would then argue that their bets were either market-making activities or simply hedges that offset risks.
Such "hedges" could encompass a lot of trades that looked awfully proprietary. A trade could seem to hedge a large business risk, like suffering loan losses if companies they lent to went broke in an economic downturn. But that might just be a bet on companies going belly up.
But then federal regulators got their hands on Volcker and set about interpreting the meaning of
Regulators decided that banks could say that they were hedging for an overall portfolio. And the banks could argue that a hedge was legitimate if it merely had a "reasonable correlation" with the security or position being hedged. It was as if the regulators had not only questioned the basis for the rules of being kosher, but had also served up a cheeseburger – with bacon on top – all very nonkosher.
"One of the great fears was that banks could avoid the rule by simply pretending that their prop trading was somehow their market-making or hedging," a Congressional aide told me. "Congress tightened the language to prevent this, and yet banks still may get away with this under the proposed rules."
The rules aren't finalized, so there's a chance the regulators will make adjustments. The authors of the Volcker Rule raised objections in a comment letter in February. "Banks could easily use portfolio-based hedging to mask proprietary trading," Democratic Senators
The problem of allowing a broad "portfolio hedging" exception is obvious. Follow the logic to its end, and you could expect to find a bank arguing that it needed to hedge its commercial banking business by buying an investment bank and hedge its banking business with an insurance company and so on.
But the bank is unabashed: "The purpose of this is to hedge the macro risk of the company," a
Alas, it wasn't the regulators who brought this to light. Instead, it took hedge funds on the other side of trades. This has led to a cynical reaction: hedge funds are hardly the epitome of upright regulatory citizens, burning to bring violations of the Volcker Rule to light.
But just because a hedge fund is biased doesn't mean it's wrong. It can be simultaneously true that hedge funds have gotten themselves into a bad trade and that
And it matters what the banks' trading partners think because the banks invoke them constantly in order to protect themselves from the Volcker Rule. The big banks wrap themselves in the mantle of market-making. Without them, they warn, liquidity – or how easy it is to enter and exit trades – will dry up.
In the case of these
So is this legitimate trading? The hedge funds don't really know what's going on at
But given how bent the regulators are to subvert the will of Congress, it would take an act of extraordinary naiveté to believe they will actually get to the bottom of it.
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|Source:||New York Times Digital|