More reason for bank rules

More reason for bank rules

May 16th, 2012 in Opinion Times

JPMorgan Chase's huge trading loss in the derivatives market is presently pegged at $2 billion, but analysts say it could go significantly higher if the market keeps running against the more bullish long-term bets in the crashing portfolio. However it ends, the bank's losing bets already have clearly tarnished the reputation it had held, until last week, as the singular example for the banking industry's argument against tighter new banking regulations under the rules that are still being written to implement the Dodd-Frank banking reform act.

Dodd-Frank was passed by Democrats in 2010, over strident Republican opposition, to create transparency and tighter rules against banks' speculative trading, especially trading in the derivatives market out of their taxpayer-backed proprietary accounts. The legislation envisioned a strict Volcker rule and was designed to prevent a repeat of the catastrophic financial implosion in 2007 that threw western economies into a recessionary tailspin, and put the United States at the very brink of a second Great Depression.

In the wake of the current JP Morgan debacle, the question now is whether Congress finally will strongly support the faction of banking regulators and lawmakers who favor imposing a strict interpretation of the Volcker Rule to flesh out the remaining rulemaking for the Dodd-Frank reform act. Or, whether Congress will allow the banking lobby and its crony rulemakers, who have lobbied furiously against tighter trading rules, to win this marathon battle.

The Volcker rule is named after its chief advocate, former Federal Reserve Chairman Paul Volcker. Simply put, it would ban banks' ability to make trades that increase their financial risks, rather than decreasing them. As one expert put it, banks could buy derivatives that act as insurance against assets they own -- for example, like fire insurance for your house, which you collect if your house burns -- but not as insurance to hedge speculative bets akin to picking a horse out of the field to win the Kentucky Derby. The former is prudent policy. The latter is casino betting that, for a bank, risks losing its customers' money -- or a taxpayer bailout.

Problem is, when the market is trending upward, commercial banks -- freed to act like Wall Street investment banks by repeal of the Glass-Steagall Act in 1999 -- tend to bet to taxpayer-backed money if they can get away with it. Hence the argument over reimposing a rule that would reinstate the firewall against proprietary trading.

Banks, of course, want to generate fog and controversy over the nature and extent of trading that they contend should be allowed under the Volcker rule. Their central issues are whether a bank could trade in derivatives for an aggregated total of risks, as opposed to segregated portfolios, and whether their derivatives trading can be farmed out to foreign operations. Other questions relate to transparency in derivatives trading, which banks resist, but which critics reasonably believe is crucial to market tracking and investor scrutiny; and to bank reserves, collateral and capital benchmarks related to trading and leveraged positions.

Yet it's notable that support for risky practices comes mainly from banks, their lobbyists, and the bought lawmakers to whom they heavily contribute. Sensible banking rules shouldn't be obscured or defeated by the smokescreens the banking industry makes in pursuit of outsized profits and rich executive rewards. If they can't support their bets, taxpayers should not be on the hook for their losses. JPMorgan's new losses confirm that maxim.