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Wall Street Laughs at Volcker

by Charlie Gasparino

Charles Gasparino is CNBC's on-air editor and appears as a daily member of CNBC's ensemble. He is a columnist for The Daily Beast and a frequent contributor to the New York Post, Forbes, and other publications. His new book about the financial crisis, The Sellout, was published by HarperBusiness.

Obama’s banking czar just delivered his reform proposal, and the big banks finally have something to snicker about—because he’s leaving untouched the risky trades that played a leading role in the financial crisis.

At first, at least, it sounded so promising: After months of being ignored by President Obama and his senior staff about how to prevent another financial meltdown, economic adviser Paul Volcker got his due. The former Fed chairman’s plan to prevent banks from having their risky trading activities subsidized by the taxpayer was being taken seriously, finally, by the man who matters most to Washington, the president, who has endorsed what is being called the Volcker Rule as the centerpiece of his bank regulatory agenda.

But looking deeper, one soon discovers that “The Volcker Plan” isn’t much of a reform plan at all. (Congressional staffers cannot even get details of the proposal and have been directed by the White House to press releases.) Instead, what we are left with is a series of statements made by a well-intentioned but ultimately misguided Volcker about how he wants new legislation that would prohibit banks that are considered “too big to fail”—i.e., Citigroup, Bank of America, Morgan Stanley, Goldman Sachs, and JPMorgan Chase—from engaging in so-called proprietary trading activities. This means they would no longer be able to use firm capital to make wild bets in esoteric markets, the kind of stuff that allegedly caused the financial collapse of 2008.

I say “allegedly” because while proprietary trading did cause some big losses at some banks during the tumultuous years of 2007 and 2008, it was really a small player in the overall collapse of the financial system. Rather, it was those trades that served the firm’s customers—namely hedge funds and other big investors—that led to the massive losses and the ultimate government bailout of the big firms that has so much of the country up in arms.

And those customer trades—at least based on what Volcker is telling reporters and, as he spoke before the Senate Banking Committee on Tuesday, lawmakers—aren’t being touched in what appears to be yet another half-hearted attempt to make sure Goldman Sachs and the rest of the fat cat bankers don’t put the country into another fiscal crisis any time soon.

All of this has given the heads of the big financial firms—bruised by a vengeful public that can’t seem to accept how the firms are getting ready to dole out billions in bonus money just a year after being bailed out—something finally to snicker about, at least in the private conversations I am having with them. “Joke” is the most common word I hear coming from top Wall Street executives when discussing Volcker’s “reform” efforts.

If Volcker thinks what he’s saying is going to stop another financial collapse, he’s crazy,” one CEO recently told me.

Here’s why: Proprietary trading—or trading that begins with an idea from an in-house trader using house money—represents just a small percentage of the firms’ activities, something like 10 percent. A much larger percentage of trades are made to “service” customers—large institutional investors that buy securities every day. Those trades are often just as risky for the firms because they use their own capital to complete orders, buying huge amounts of bonds, and holding them on their balance sheets until investors are ready to complete their purchase.

[snip]

The point here is that nothing Volcker is looking to impose on Wall Street in the coming weeks recognizes that it was customer trading—the stuff Goldman and the rest of Wall Street often tout as doing “God’s work”—that played the leading role in the financial crisis.

[snip] . . .Volcker hasn’t been involved in government since leaving the Fed nearly 25 years ago—he’s simply out of touch with the reality of the modern financial system. (Emphasis added)

Either way, no legislation would be better than bad legislation, which this plan seems to be. And that’s why Wall Street is snickering. (Emphasis added)

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This is disconcerting to say the least.

-- Edited by Sanders on Wednesday 3rd of February 2010 11:42:50 AM