How Levin’s crisis report recasts the Volcker Rule

By Felix Salmon
April 14, 2011

After the Financial Crisis Inquiry Commission fractured into bipartisan incommensurability, I had little hope for the Senate’s report into the financial collapse. But my initial impression is that it’s a great piece of work — almost incredibly so, given that it’s got bipartisan support.

The whole 5.9 MB, 650-page report can be found here, and there are another 5,800 pages of appended documents which can be found from the links at the bottom of this PDF press release. Given the enormous amount of work which went into collating and writing this report, I have to say I’m disappointed in the way in which it doesn’t even have its own web page — this material should all be online, easily indexable and searchable.

I’m going to take my time with this report. But to get a flavor of its tone, take a look at the list of recommendations which are summarized on pages 12-14 (or pages 20-22 of the PDF). They basically take the armature of Dodd-Frank and toughen it up substantially: Carl Levin and his colleagues clearly reckon that Dodd-Frank is a good start, rather than a response which is sufficient in and of itself.

I’m particularly taken with the way in which the report sees the Volcker Rule as an ethical issue, rather than as a moral-hazard issue. As I recall, the stated justification for the Volcker Rule was that it’s ridiculous for the Federal Reserve to give valuable access to its discount window to banks who can just take that money and gamble it on proprietary trades. If people want to gamble, that’s fine, but they shouldn’t do so with taxpayer dollars.

But Levin’s report puts the Volcker Rule in a different light. It quotes Jeremy Grantham:

Proprietary trading by banks has become by degrees over recent years an egregious conflict of interest with their clients. Most if not all banks that prop trade now gather information from their institutional clients and exploit it. In complete contrast, 30 years ago, Goldman Sachs, for example, would never, ever have traded against its clients. How quaint that scrupulousness now seems. Indeed, from, say, 1935 to 1980, any banker who suggested such behavior would have been fired as both unprincipled and a threat to the partners’ money.

It then goes on to say that “the Dodd-Frank Act contains two conflict of interest prohibitions to restore the ethical bar against investment banks and other financial institutions profiting at the expense of their clients”.

The Volcker Rule has yet to be nailed down, of course — and there are serious questions over whether it will ever be enforceable. But if it’s written in a principle-based way, then I think this is a very useful principle to include. Is an investment bank profiting at the expense of its clients? If so, it’s probably violating the Volcker Rule.

In the case of something like the Abacus transaction, of course, the answer is clearly yes. Goldman Sachs said over and over again that IKB, one of its clients in that transaction, was “sophisticated”, as though that in and of itself absolved Goldman of any responsibility to the German bank. But a conflict-centered Volcker Rule would not include carve-outs for sophisticated clients, and might well prevent such transactions in future.

Levin’s report says hopefully that just such a rule can be “well implemented”, and would “protect market participants from the self-dealing that contributed to the financial crisis”. I’m not convinced. But it’s certainly worth a try.


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You are almost certainly going to get comments from those who will say that both the investment banks and their institutional clients are consenting adults, and should be able to do whatever they want, irrespective of this thing you call ethics.

However, at some fundamental level, our entire financial system is based on trust. It’s not merely trust in the government, but also a hard and definable level of trust among counterparties in any exchange. If that is irretrievably lost, I do not hold out hope for the future of society in general.

Posted by Curmudgeon | Report as abusive

Is it just me, or did it occur to anyone else that the main purpose of Obama’s speech yesterday was to push Senator Levin’s report to page three, below the fold?

Posted by LadyGodiva | Report as abusive

“Is an investment bank profiting at the expense of its clients?”

Lets explore that premise by substuting a different industry for investment bank…

Is a car dealership profiting at the expence of it’s clients?

Is a restruant profiting at the expense of it’s diners?

Is an airline profiting at the expense of its passengers? -O.K. that’s actually a bad example since they preputally lose money… but you get the drift right?

All profitable businesses generate their profits via their customers.

Posted by y2kurtus | Report as abusive

The consenting adults defense does not work when one of the parties deliberately withholds pertinent information from the other party. That defense would only work if Goldman was compelled to completely open all its books to IKB for due diligence. Goldman could not do that, because so much of the pertinent information is privileged information. Does anyone really think a “Chinese Wall” really keeps privileged information from being shared between bankers and investors?

Think about this. In OurBank, we have a banker side and a prop trader side. One of the prop traders is making a deal, and one of the bankers has inside information that the deal will be a disaster large enough to bankrupt the whole enterprise, and throw him out of a job. Does anyone really believe that banker is going to stand by and say nothing to the trader?

Econ 101 assumes both parties to a transaction have “perfect information”. That never happens in the real world.

Posted by randymiller | Report as abusive

y2kurtus- There are laws that protect you if a car dealer gives you a lemon or a restaurant gives you bad food- its I’m baffled how the financial services industry thinks different rules should apply to them.

Posted by AdamJ23 | Report as abusive

Some realism, please. We had John Paulson working in concert with Goldman Sachs to create investments they both knew would fail. Goldman then actively touted those investments to its clients, even as both put enormous wagers against that trash. In no known universe does that make ethical sense, and in most of those systems the principles would be in jail.

So don’t give me that stuff about consenting adults. The metaphor strikes a little bit too close to home.

Posted by NCimon | Report as abusive

From a completely different angle: Into the ‘eighties Quotron, the market data company, offered a product called the “Restricted List”. If a firm was doing an investment banking deal with company then a flashing ‘R’ would appear on the quoteline after its symbol. This was to inform the trading part of the firm that trading in that securitiy was restricted.

This product was available only on the Quotron 800 product line and involved telephone lines from the computer upon which the restricted list was edited to the computers that displayed the flashing ‘R’. The 800 product line was programmed in assembler. Quote data came from a regional database which got it from SIAC who got it from the exchanges. The quote data was displayed on the bottom of the screen and the flashing ‘R’ was inserted after the symbol. Not so hard to do in assembler but almost impossible to do in Unix which treats everything as a file. The successor to the Quotron 800 was a Unix based machine. So far as I know the restricted-list product was dropped. There was no equivalent ‘easy’ way to maintain the Chinese wall across a firm.

Quotron was acquired by Reuters after a tortuous detour through CitiCorp so you–as a Reuters employee–might find that they now offer an equivalent product. I have left the industry.

Posted by bidrec | Report as abusive

At the expense of one’s client is how the parasite thinks. Businesses have profitable transaction with clients, sometimes with a one-off, sometimes with a longterm setup, but always with an eye on longstanding relationships. Goldman can burn bridges with ACA or IKB because there are many other clients to profit at the expense of, as well as tacit government approval to the game. Small community businesses, whether car dealerships or restaurants cannot afford to function as parasites, perhaps because they are stronger moral creatures, but more probably because they would fail.

Posted by thispaceforsale | Report as abusive

“As I recall, the stated justification for the Volcker Rule…”

Clearly you didn’t pay attention to the Volcker Rule debate then. The inherent conflict-of-interest was always the stated justification, including Paul Volcker’s stated justification, for prohibiting prop trading. Levin’s report adds nothing to the debate. (In fact, Levin contributed a provision to the final Volcker Rule that everyone — other legislators, regulators, bankers, even Paul Volcker — admits is incoherent.)

Posted by Than | Report as abusive

Actually, the FCIC does have a website with report ( Since the commission does not exist anymore (and neither does their funding), the website has been archived by Stanford –

Posted by thatash | Report as abusive