Occupy’s amazing Volcker Rule letter

By Felix Salmon
February 14, 2012
Occupy the SEC.

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One of the saddest aspects of the financialization of the US economy is the way in which America’s best and brightest found themselves working on Wall Street, rather than in jobs which improved the state of the world. Proof of this comes from the absolutely astonishing 325-page comment letter on the Volcker Rule which has been put together by Occupy the SEC; it’s pretty clear, from reading the letter, that the people who wrote it are whip-smart and extremely talented.

Occupy the SEC is the wonky finreg arm of Occupy Wall Street, and its main authors are worth naming and celebrating: Akshat Tewary, Alexis Goldstein, Corley Miller, George Bailey, Caitlin Kline, Elizabeth Friedrich, and Eric Taylor. If you can’t read the whole thing, at least read the introductory comments, on pages 3-6, both for their substance and for the panache of their delivery. A taster:

During the legislative process, the Volcker Rule was woefully enfeebled by the addition of numerous loopholes and exceptions. The banking lobby exerted inordinate influence on Congress and succeeded in diluting the statute, despite the catastrophic failures that bank policies have produced and continue to produce…

The Proposed Rule also evinces a remarkable solicitude for the interests of banking corporations over those of investors, consumers, taxpayers and other human beings. In their Overview of the Proposed Rule, “the Agencies request comment on the potential impacts the proposed approach may have on banking entities and the businesses in which they engage,” but curiously fail to solicit comment on the potential impact on consumers, depositors, or taxpayers. The Administrative Procedure Act requires that, prior to the enactment of a substantive regulation, an agency must give “interested persons” an opportunity to comment. The Agencies seem to have lost sight of the fact that “interested persons” could include human beings, and not just banking corporations.

There’s lots more where that comes from, including the indelible vision of how “the Volcker Rule simply removes the government’s all-too-visible hand from underneath the pampered haunches of banking conglomerates”. But the real substance is in the following hundreds of pages, where the authors go through the Volcker Rule line by line, explaining where it’s useless and where it can and should be improved.

For instance, there’s a massive repo loophole in the proposed rule, which basically allows banks to move all their prop trading to their repo desks.

And then there’s the even bigger market-making loophole, which, unlike the repo loophole, actually exists in the original statute. Still, Occupy the SEC does a great job in glossing why it’s a bad idea:

Market making is an indispensable component of liquid, efficient markets. This service, however, simply does not belong in banks…

The bank lobbying effort is certainly understandable: market making is a profitable business and one that banking entities certainly do not want to lose. It is well-known that the major dealers have always fiercely guarded their dominance of market making, particularly in the less regulated OTC markets. Firms that attempt to enter this business are regularly strong-armed through anti-competitive arrangements with inter-broker dealers… Despite the banks’ desire to continue reaping such profits, their contention— that banking entities alone are able and willing to provide this valuable service to the market, and that regulation will cause irreparable damage to the financial system at large—is unfounded and nonsensical.

In the proposed rule, banks can claim to be “making a market” in illiquid instruments when they’re only on one side: buying and not selling, or selling and not bying. They’re even allowed to claim to be making a market when they’re unwilling to provide executable bids or offers at all. (After all, if such situations never occurred, then the market wouldn’t be illiquid in the first place.) It’s pretty easy to see how a market-maker’s inventory can morph into a proprietary trade, under such circumstances.

As the letter says, “an unfortunate consequence of the generalized language throughout the Proposed Rule may be the shift of risky practices out of liquid and transparent markets into the less regulated illiquid and OTC products” — there’s a real risk, here, that the Volcker rule could actually make bank trading more risky, rather than less.

The letter also picks up on the Volcker Rule’s proposed treatment of carried interest. As we all know from following the Romney campaign, carried interest is treated as capital gains for income tax purposes. But in the Volcker Rule, it’s treated as fee earnings. As the letter says, “carried interest should not provide loopholes to banking entities and to covered funds in both the realm of taxation and the realm of regulation”. Carried interest is income, yes, but it’s also an ownership stake — but under the proposed rule, it’s exempt from the definition of “ownership interest”. Which seems silly.

Very well done, then, to Occupy the SEC — a clear example of how the Occupy movement is making incredibly detailed and substantive demands of our legislators and regulators. This letter is many things, but inchoate it is not. Let’s hope that the SEC gives it the full attention it deserves.


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Let’s hope pigs fly.

Posted by maynardGkeynes | Report as abusive

Great Article. I think that the following article is related to the topic.
http://modernfinancereport.wordpress.com  /2012/02/14/will-this-be-the-first-elec tion-where-class-trumps-race/

Posted by EricLam | Report as abusive

So, after several posts by Felix with which I largely agreed, I suppose this sort of mean reversion was likely. A couple points here don’t make sense to me.

First, where does market making belong if not in banks? Most of the shadier moments of the crisis were decisions to find ways to provide Fed funding access to entities who we discovered were important (the independent investment banks, AIG, AmEx, money market funds) but weren’t regulated as banks. So, we therefore had things like the near overnight approval of Goldman and Morgan Stanley becoming bank holding companies, or the Fed desperately seeking ways to use banks as conduits to find legal ways to lend to non-bank entities. If we believe that market-making is highly important, demanding that function has to be outside of banks, which are more regulated than other financial institutions, just sets us up to privatize profits, socialize losses if/when market makers run into trouble in a future crisis.

Posted by realist50 | Report as abusive

Secondly, I take issue with the underlying premise that informs this post, Occupy the SEC, and parts of the Volcker Rule. I can understand making sure that banks and their regulators reasonably understand the risks that banks have taken on, including how levered banks actually are, which may justify keeping banks out of some of the more esoteric parts of the derivatives market, for example, or limiting a bank’s equity holdings to a relatively low percent of its capital.

At heart, though, what banks do, including under the Glass-Steagall, traditional commercial bank model, is take on a variety of risks, with credit risk chief among those risks. So I don’t understand the current common wisdom that says, “a bank holding a bond on its balance sheet equals proprietary trading, which is bad”, but “traditional banking, taking deposits and lending money, equals good”, when making and holding loans or buying bonds both fundamentally provide the same risk exposure to borrowers. It seems that we also gloss over a lot of circumstances (the S&L’s, Continental Illinois, Seafirst Bank, Citibank’s near demise in the early ’90′s, Wamu and Wachovia in the recent crisis) that says that banks can blow up plenty easily just by taking deposits and making (too many bad) loans.

Posted by realist50 | Report as abusive

I object to the opening paragraph of this article which attempts to portray those intelligent people who took jobs on Wall Street in a bad light.

Let me ask you a question. Do you like having access to Google? Do you enjoy your smartphone? The laptop you probably wrote this article on? Do you enjoy the roads you drive on and the bridges you cost? Is it good that you were given antibiotics as a child to get you through an infection that might otherwise have been fatal? I could go on.

All of these things that you depend on for your current quality of life are a direct result of the financial system that has been in place for the past 500+ years, which little change other than the scale at which it operates due to the brilliance of the business people and technologists who went to work “on Wall Street.” Wall Street is the engine that funds almost everything you touch in your life.

Of course, all of this is based on the desire of people to get a return on their investment. People put money into the market in order to make money. So the entire market depends on greed. The problem is that greed has been allowed to run rampant among a small minority of Wall Street participants that, because of what they were doing, had a huge impact on the markets. The vast majority of people working on Wall Street are helping to run the engine that keeps us all fed, clothed, and interconnected.

In order to stop this rampant greed we need the efforts of groups like Occupy SEC and I applaud their efforts. But get off your high horse. You need Wall Street and you need it to be run by the smartest people you can find. Such as the people who wrote the Volker Rule letter, who by the way, work or worked on Wall Street.

Posted by mantisny | Report as abusive

@mantisny: I don’t object to anything in your statement. Indeed, I don’t think Felix would object, either, from what I’ve read.

But agreeing that market making and capital allocation are essential functions of Wall Street doesn’t mean that I have to approved of the fundamental structure of modern finance. The financial system was perfectly capable of fulfilling these core missions when it was half its current size, and before the invention of algorithmic trading, the rise of OTC products and systemically important FIs.

You’re essentially arguing against a position no one is taking. No one has said that Wall Street doesn’t have essential, core functions. But many people believe that these core functions have been elided in favour of a behaviour of risk-taking and rent-seeking that compromises not only the ethics of the industry, but the stability of the financial system itself.

And to the extent that the outside rewards in this type of socially damaging activity have drawn bright, capable people away from other functions, then yes, it is a tragedy. But believing that doesn’t mean that I have to disbelieve all of modern finance.

Posted by strawman | Report as abusive

Maybe you should ask these geniuses how exactly prop trading at the banks was a major contributing factor to the financial crisis.

Posted by Danny_Black | Report as abusive

realist50, the only redeeming feature of the letter is that it has the world liquidity in it, something that actually is important and was a contributing factor.

Posted by Danny_Black | Report as abusive


You should have read the letter before slamming it.

From the piece: “In the words of a banking insider, Michael Madden, a former Lehman Brothers executive: “Proprietary trading played a big role in manufacturing the CDOs (collateralized debt obligations) and other instruments that were at the heart of the financial crisis. . . if firms weren’t able to buy up the parts of these deals that wouldn’t sell. . .the game would have stopped a lot sooner.”

Posted by CharlesHClarke | Report as abusive

The banks have been running as fast as they can away from the reality that Market Making is best done by computers. The only way they’ve found to preserve their immense profit margins is to create new products that the technology cannot automate, as it trades OTC (off-exchange).

The idea that banks must do market making ignores the fact that no industry is better suited to this than the tech industry. The phone business is still a huge sorts of profits to the banks, and the only way they’ve been able to preserve it is through a nuclear arms race of financial engineering.

I agree with Occupy the SEC that Market Making need not happen in banks, and certainly not in banks implicitly backstopped by our tax dollars.

Posted by BobRobinowitz | Report as abusive

Charles, i flicked through it. Weird they would quote leh “executive” given leh was not a player in cdos and what sunk it was boring old commercial real estate loans

Posted by Danny_Black | Report as abusive

Hey, it’s really cool how you glide over all the riots, rapes, property damage, and general contempt for others’ rights that has typified the Occupy movement as you search desperately for some way of portraying them positively.

Posted by 13thLetter | Report as abusive

@13thLetter – You are confusing them with Goldman Sachs.

Posted by maynardGkeynes | Report as abusive

If you can’t attack the message, attack the messenger, eh? Facts are optional, of course.

Posted by dunwawry | Report as abusive

13thLetter, you clearly don’t understand the importance of OWS. If you were as “whip-smart and extremely talented” as them you would realise they are not raping or destroying property, they are redefining the meaning of “consent” and liberating people from the concept of “mine” and “yours”.

Posted by Danny_Black | Report as abusive

BobRobinowitz, “the fact that no industry is better suited to this than the tech industry”. Thanks, needed the laugh.

Posted by Danny_Black | Report as abusive


Typical troll. So Lehman wasn’t a “player” in CDOs?

http://articles.businessinsider.com/2010 -03-17/wall_street/30061008_1_lehman-bro ther-lehman-report-valuations

Posted by CharlesHClarke | Report as abusive


Here, let me help you:

http://lmgtfy.com/?q=Lehman+Brothers+CDO s#

Posted by CharlesHClarke | Report as abusive

@ mantisney

LOL the banking industry gave us laptops, roads and bridges, and antibiotics. (Indeed, our whole way of life in the last 500 years…). Did they invent the internet and discover Love Canal, too?

They shuffled money around for the last 500 years, that’s what they did. Any one of them could have replaced any other one of them. None of them invented anything.

Posted by orangutan | Report as abusive

Charles, I know… evil me confusing you with facts.

http://economicsofcontempt.blogspot.com/ 2010/07/lets-play-name-that-investment-b ank.html

Posted by Danny_Black | Report as abusive

orangutan, yeah and all that was funded by hot air.

Posted by Danny_Black | Report as abusive

Any rule, in a market, inspires its opposite.

The Volcker Rule is not an inflexible thing, but only a caution to our lawmakers that they NOT robotically follow any prescriptive rule but must HEED conflicts of interest and current industry structure in setting any rules. And if industry structure is a predicate of a rule then the RULE must change as industry structure changes. Our government is not able to comprehend this or act upon it, these days. Things have gotten too complex, too much a Tower of Babel.

Currently, banking is a cartel/monopoly. It imitated government in making itself so, and it also set out to control government for its own benefit, at the nation’s expense. Our politicians and regulators were unsophisticates. They were bamboozled by Wall, out of a combination of incompetence and malice. Our lawmakers need now to understand how to manage conflicts of interest in the CURRENT state of our markets. NOT the state of the markets circa 1936. They need to know that when dealing with dark pools, or securities–or insurance firms–if you wish to protect the public from easy, damaging frauds, you have to set up certain pillars. You cannot “insure” away all risks by declaring everything to be nationally guaranteed–this is nothing but socialism. You must have the purgative cleansing effect of the market.

To function without fraud, markets must operate under the clear light of transparency that elucidates, for all (not just the few), all material facts about a proposed market transaction. It is ONLY in this way that you avert fraud, dark pools, and exploitation of the innocent, which is the proper goal of government. Access to value or trading may also not be hoarded for the exclusive benefit of a privileged class. It should be made freely available, on an equal basis to everyone, who are given an even shot at the chase, say, on a market exchange scrutinized beforehand and regulated-to-be-fair. Not a private racket made opaque and the quarry of cronies. When Wall St. went about handing out IPO shares (cash bribes) to congressmen and women, and creeps like Bernie Ebbers and Skilling or Lay, it had become brazen in assurance that no one would call them on their erection of private rackets or misuse of inside information.

Exchanges are for routine, fungible, replicable market transactions. Private contracts are for more sophisticated private individual bets. The common law rule on derivatives, or betting (and also, for “insurance”) is the best one. Courts should not enforce any contracts for transactions among parties who have no tangible, real connection to the matter at interest. This is related also to the rules of standing in the law. People’s economic interests cannot be robo-controlled by others. There are many limits on the exercise of the class action exception to the rules of standing, and for good reason.

The real bills doctrine of economics is a key principle much ignored today, but it reflects the economic structure of the law. The law is a body of wisdom largely ABOUT economics, which has accreted over time that has deep empirical roots. Economics cannot be manipulated from above. Certainly not by “rules” devised the day before yesterday by idiots (full of sound and fury, signifying nothing).

Posted by missprism | Report as abusive

Insurance with no prudent reserves (even if it is known by some other name – like credit default swap) is nothing more than a scam, & it has always been a scandal waiting to happen. That Greenspan didn’t pull the plug on AIG is fantastic. But there were others who could have done so, yet they didn’t stop it either.

(Moreover, does it seem at all right that the basic concept of CDS made it possible for anyone to take out a policy on my car, for instance, sell short that CDS, crash the market (my car) and also make a huge pile of profit? Moral hazard at all?

Did anyone ever stop to think that basic real estate and banking laws require the preservation of loan documents which contain, among other things, transfers of titles and deeds?

These are but two of the more extraordinary violations that occurred in the brilliant and ingenious technocratic arena we call Wall Street. The best and brightest – and the most trusted senior people – gave us this perversity. It is naive to think so highly of the rigged game that is Wall Street investing. It is sheer hubris to expect taxpayers who were defrauded through the necessity of bailouts to have any respect for such treachery. So, realist50, I suggest you try to add to the efforts here and improve regulations that lead away from such monstrosity rather than criticize the efforts of those who are genuinely concerned.

Posted by ezdidit | Report as abusive

ezdidit, firstly you clearly don’t know what the word moral hazard means. Secondly, this is one of the big lies of the financial crisis that somehow a company can “make the market crash” or that somehow because a bet paid off big that it must have been “designed to fail”. Thirdly, has there really been that many cases in percentage terms where the loan docs are not preserved?

missprism, again you clearly don’t know what a dark pool is and why they exist. There already exist laws stating that a proposed transaction needs to be accurately described. What we have seen is that – retroactively – when a bet pays off that somehow AT THE TIME the motives of one side is now being made material. Note on an exchange you DON’T have that information, I don’t need to give a long list of why I am selling C when I hit the button.

As for not having a material interest, what is your material interest when you buy equities? You think that stock is going to appreciate or because it matches some requirement in your investment mandate. Explain why that is different from trading a CDS…

Posted by Danny_Black | Report as abusive

A much more intelligent comment on this letter:

http://economicsofcontempt.blogspot.com/ 2012/02/volcker-rule-predictions.html

Posted by Danny_Black | Report as abusive

@mantisny Are you f*&cking joking? Every single thing you cite as the product of our financial system (and implicitly, part of Wall Street’s bounty rained down on us little peons) is largely or entirely the product of government-funded basic research and development. Google is a creature of the internet, in whose creation Wall Street had a role that was marginal at best. While many antibiotics and other medical advances are developed by pharmaceutical companies, their understanding of human biology is largely based on research funded by the NIH, universities, and other government bodies. And to then cite roads and bridges as somehow a product of Wall Street? All your post demonstrates is how necessary the work Occupy the SEC and other Occupy-related initiatives are – you’re not the only one who needs this sort of reality-distorting free market idolatry washed out of their brain with a firehose.

Posted by paperbag | Report as abusive