The esteemed former Fed Chairman, Paul Volcker, introduced a very simple regulatory concept that bears his name: The Volcker Rule. It was part of the Dodd-Frank regulatory reforms passed after the financial crisis of 2008-09.

There has been enormous pushback against what should be a simple piece of prophylactic rules on proprietary trading by depository banks (see this Jamie Dimon commentary as an example). Why? The profits of speculation goes to banks, driving bonuses and compensation; but the ultimate risk of loss lay with the FDIC and taxpayer. If the banks blow up, someone else besides the banker pays.

Privatized gains, socialized losses.

I want to take a few moments to briefly explain why this rule is so important to taxpayers, especially following the collapse of MF Global and the loss of billions of client assets.

Recall the basic facts of MFG: Management engaged in leveraged speculations with monies — whether it was their own or clients became irrelevant as the losses were so great as to wipe out much more capital than the bank actually had. Billions in losses meant MFG was insolvent and was wound down. On the winning sides of those trades were folks like JPM and George Soros. It is neither their duty nor obligation to verify whose money is on the other side of the trade — the clearing firms make sure the trade settles.

Those trade settlements are the only possible outcome. Why? Imagine a burglar robs a house of cash, goes to a casino and loses the money playing Roulette. The Casino settles that bet, it clears — and the burgled homeowner can never recover the money. Exchanges work the same way. They simply cannot validate the capital sources of every transaction. In the case of MFG, he money wasn’t even burgled — it was simply entrusted to an entity that became so insolvent thru excess speculation that even money in “Segregated accounts” was highly compromised.

And therein lay the dirty little secret of modern banking: THERE IS NO SUCH THING AS A SEGREGATED ACCOUNT. It is simply a helpful way to think about money and banking; it does not exist in the real world.

Consider your basic bank account — checking, savings, passbook, etc. We go through massive contortions to create an illusion that your money is yours, that its safe and sound in a bank with your name on  it, in your own virtual safe deposit box. But that is simply not the reality of modern banking. What you perceive as “your money” is little more than an electronic journal on the banks accounting ledgers.

Fractional reserve banking means that the $100 you deposit is lent out — only $10 of your $100 is kept in reserve. Under normal circumstances, with thousands of depositors and millions of dollars, the banks have no trouble giving customers who ask for their money back the full amount at anytime. But it is not as if your money is sitting in an account waiting for you — you merely have a claim on those monies, and that claim is insured by the FDIC, and backed by taxpayers (theoretically).

You are, in fact, a counter-party to your bank.

In the old days, banks were boring. 3-6-3 banking meant borrowing at 3%, lending at 6%, be on the links at 3pm. It was simple. Banks were a utility, making reliable steady money, so long as they didn’t do anything too stupid to screw it up. Glass Steagall, the depression era legislation, prevented them from engaging in the sort of risky Wall Street speculation that caused so much trouble over the years. Think MFGlobal to get a better understanding of what is involved.

Thanks to the sheer ideological idiocy of Phil Gramm, enabled by the corruption of former Treasury Secretary Robert Rubin and the hubris of former Treasury Secretary Larry Summers, Glass Steagall was repealed. Thus, banks could be as stupid as they want to be — and you get to foot the bill.

What does all this have to do with the Volcker rule and MF Global? It is quite simple: Today’s post Glass Steagall repeal Bankers engage in leveraged speculation that potentially could blow the bank up. They did it to themselves with sub-prime mortgages; have no doubt that someone is working on the next ‘financial innovation’ whose losses will be even bigger and better than RMBS and CDOs.

When the next bank blows up — note I said when and not if — their depositors will become counter-parties. Those depositors are you, just like MF Global’s. Only, you as counter-part are not first in line with a claim on the monies — the folks on the other side of the trade get first dibs.

So this bank blows up, the trades settle, the counter party banks/brokers get paid, and whatever is left (if anything) goes to depositors. The FDIC will make good up to $250,000. FDIC’s budgets comes from a small fee on banks. If the losses are great enough, it will exceed their budget and so the taxpayer than makes up the difference.

The risks and rewards are, to use a big word, “asymmetric.” Hit a home run as a trader or banker, collect a huge bonus. Lose it all and then some, and  the taxpayer is on the hook. Anyone who fails to see the simple math of this either spends their days shilling for banks or are acting as CEO mouthpieces.

Privatized gains, socialized losses.

Category: Bailouts, Regulation

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

62 Responses to “MFGlobal Reveals You Are A Bank Counter-Party”

  1. DeDude says:

    I hope this is your next editorial, because it cannot be repeated often enough.

  2. [...] Barry: The dirty little secret of modern banking: THERE IS NO SUCH THING AS A SEGREGATED ACCOUNT.  (TBP) [...]

  3. two things come to mind..

    ‘back in the Day’ “MFG.” used to be the abbreviation for “Manufacturing”..

    now, after the abbreviation of our Manufacturing Economy, ‘We’ get MFG (MF Global)..
    ~~

    and, the AAPL touts that swoon over their (alleged) U$D ~100/sh. in ‘Cash’..

    is that a Liability, or an Asset?

  4. cpd says:

    Well articulated. The other point I would make to get to the enormity of the potential problems is derivatives. They rank ahead of depositors. So, if a big bank fails, it is inevitable that taxpayers will pay up big because they will have to cover all the derivative losses before they even get to protecting depositors. The transfer of Merrill Lynch’s derivatives to the BofA banking entity last year was particularly offensive when considered in this context. The bankers know exactly how it would play out if they got into trouble.

  5. ilsm says:

    Willard Romey will not apologize for being a “success” in this game.

  6. toddie.g says:

    In case you missed it BR, Phil Gramm was just interviewed on Bloomberg and continued to blame everything on Fannie, Freddie and the CRA as always.

    Betty Liu never challenged any of his outrageous assertions. I don’t understand how they can do such a softball interview. Maybe you can hand deliver a copy of Bailout Nation to Betty and give her the real story.

    ~~~

    BR: If they trotted that decaying old geezer out, they must be concerned.

  7. Petey Wheatstraw says:

    A related story at Business Week (link borrowed from Naked Capitalism):

    http://www.businessweek.com/finance/occupy-the-sec-weighs-in-on-the-volcker-rule-02142012.html

    Once again, we have a stunningly blatant example of crooked legislative/policy capture. What’s puzzling is that even though we can define and understand it, we can’t seem to find the societal will power or coordination to gain enough traction to push back.

    Sadly, and as with many other things, we won’t wise up and act in our own defense until we begin to feel the pain that results from our collective apathy (and even when we feel the pain, some, in an effort to continue supporting their personal biases and/or to avoid admitting past mistakes, will use the disprovability of cause and effect to double down on the self-imposed ignorance that allows such conditions to exist, in the first place).

    In the gritty, blue collar neighborhood where I grew up, there was a saying (that might have originally been in reference to mules): “that person is so dumb, you have to hit them with a brick before you can teach them anything.”

    I’m beginning to fear that my old neighborhood was accurately representative of the demographics and the mentality of the American people, broadly.

    The Iraq war is the latest example of a simple truth: If theres one thing more dangerous than stupid, it’s stupid, injured, and insulted.

  8. davefromcarolina says:

    I don’t believe Phil Gramm is an ideological idiot. I think he knew exactly what he was doing, and his public statements confirm this. The idiots are the people who still believe, against all evidence to the contrary, that Phil Gramm has any ideology beyond “gimme.”

  9. Moss says:

    This is why the currency needs to be backed by a hard asset like Gold. The banksters and their pimp politicians talk out of both sides of their mounts. Let them fail, let them fail say the right wing nuts knowing full well that the whole house would come tumbling down because of the lack of collateral backing the so called assets. Derivatives are the banksters preferred way to blackmail the whole system. The Fed goes along since they work for the banksters.

  10. constantnormal says:

    BRING BACK GLASS-STEAGALL

    Nothing less will do. So long as banksters are allowed to gamble in the markets with OPM, and are also allowed to accept customer monies on deposit for legitimate banking activities, we are going to see this happen. It’s why Glass-Steagall was created.

  11. Orange14 says:

    +1 to DeDude’s comment though I think this needs to be a little sharpened up and go on the Op-Ed page of either the NYT or WaPo. One of the clearest explanations of why the rule is needed. Great job BR!

  12. theexpertisin says:

    And to think, MF Corzine (D-NJ) was under serious consideration to be come Treasury Secretary and continued to be a conduit for big Dem projects. I guess we should thank Geitner for agreeing to stay on board.

    Lax regulations make it tempting for some/many to abuse the system. It takes a crook like Corzine to raise current financial regulations to a criminal art form. You have to appreciate the job Chris Christie is doing following an “act” like that. I doubt if Corzine decided to abuse OPM recently.

  13. constantnormal says:

    @MEH

    “and, the AAPL touts that swoon over their (alleged) U$D ~100/sh. in ‘Cash’..

    is that a Liability, or an Asset?”

    Are you stoopid? Would you rather have $100B in cash, or in some dubious and ill-advised business venture? They have repeatedly said that they are looking to put that money to use, but are not going to rush into it. And they are doing so, having made several strategic semiconductor and software company acquisitions over the past few years.

    As many who lament the increase on dividend taxation will attest, there are some good reasons to avoid the hypothesized “double taxation” on dividends.

    Just think of AAPL as a $475B fund, that has a portion ($100B) of its assets invested in Treasuries. Does that really sound so bad to you?

    In any event, AAPL seems to be doing just fine, without the benefit (?) of your counsel. Fine enough to have accounted for over 70% of the profit growth of the entire S&P 500 in 2011Q4 …

    http://www.ft.com/intl/cms/s/2/242a84f6-5657-11e1-8dfa-00144feabdc0.html

  14. GetReal1 says:

    BR, excellent post!

    Have to agree with “constantnormal” here: BRING BACK GLASS-STEAGALL

  15. constantnormal says:

    Strike the “good” from my usage of the phrase “good reasons to avoid the hypothesized” … I’ll not make value judgements on this.

  16. Phaedrus says:

    MF Global goes beyond fractional reserves (which are nearer to zero than 10%) and the game being rigged (which it is). There “segregated” was not segregated. The money was taken and pledged against bad bets, and the form of bankruptcy chosen (stock brokerage) allowed customers’ claims to be subordinated to the banks, which would not ordinarily be the case (commodities broker). Customers were uniformly unaware that their money was being pledged (rehypothecated) because it was buried in the fine print legalese of their broker agreements and I believe strongly that criminal behavior was involved. I also believe that the Big Boyz are protecting each other. Money does NOT vaporize.

    A change you can believe in is that brokerages are going to lose A LOT of customer money, that is, it will leave, as a result of the MF Global debacle. The game has changed. Trust has been lost in a big way and will not be recovered. See Francine McKenna, Chris Whalen and Jesse’s Café Americain.

  17. constantnormal says:

    Apologies if I misinterpreted your snide remark about Apple touts …

  18. machinehead says:

    ‘THERE IS NO SUCH THING AS A SEGREGATED ACCOUNT.’

    Corollary:

    ‘THERE IS NO SUCH THING AS A SOCIAL SECURITY TRUST FUND.’

    Have a good day …

  19. S J Morton says:

    Sure, it’s all well and good to insulate depositors from the risks of proprietary bank trading, except:

    –Prop trading had absolutely nothing to do with the financial crisis. Zero. The financial crisis was caused by credit problems, and prop desks are far too nimble to get hooked on illiquid nuclear waste.

    –Now that the investment banks are gone, only commercial banks are left to provide market-making liquidity. If you take away that activity from them, liquidity will drop sharply, no way around it.

    –The Volcker Rule attempts to allow banks to make markets without any residual trading risk through a layer of bureaucracy so deep that the consultants are having a field day sorting it out. The rules are unworkable, and will drive the banks out of the market-making business.

    You make a valid point about protecting depositors from the foibles of bank decisionmaking, but the Volcker Rule is all wrong. Like many regulations, it closes the barn door after the horse is long gone.

  20. rd says:

    This is why I have made a number of comments about MF Global. It is the canary in the coal mine for the current condition of the financial sector, customers, and taxpayers. Since it is a futures broker, it falls into all sorts of regulatory cracks so the customers can get hung out to dry with no FDIC/SIPC etc. to hand over cash and securities to them in a failure.

    I don’t trade futures, so I don’t deal with MF Global-type firms. But it has been clear that the entire regulatory system is aligned on this one to ensure that customers’ segregated accounts are the plankton in the food web to get munched on by everybody else. There is no reason to believe that it would be any different in another financial crisis. Once you move beyond FDIC and the limited value of SIPC, the little guy is completely on his own in a sea surrounded by sharks. The regulators are “helping” by throwing chum into the water to get the sharks excited.

    The Volcker rule is nowhere near as solid as Glass-Steagal, but it is a start. There should be no waivers and exemptions as there are enough loopholes in it already to drive multiple MF Globals through it.

  21. Doofus says:

    I concur with the other comments here regarding this piece either becoming the bulk of your column OR being adopted and reworked by an editorial board of one of the major papers.

    The term that you haven’t included, moral hazard, is important to include.

    Many Senators and Representatives are A-OK using the term to rail against social welfare programs. “If we continue to give human persons a free ride, they won’t go out and find a productive way to contribute to society”, they say, ideologically pounding their fists and waving their arms, spittle flying.

    But the corporate persons – the banks and related large financial institutions – it’s just fine to subsidize their risk taking with corporate welfare.

    As Orwell said (paraphrasing), some persons are more equal than others.

  22. Arequipa01 says:

    “You are, in fact, a counter-party to your bank.”

    One of the best things you’ve ever written. I would hasten to add, the Federal Government claims you* and all the value of your labor as an asset and has pledged you and it as collateral.

    *’you’ as in everyone reading this (go ahead, scoff, you’ll feel better) and not reading this comment.

  23. [...] Ritholtz on the Volcker Rule: There has been enormous pushback against what should be a simple piece of prophylactic rules on [...]

  24. gman says:

    S J Morton Says:

    “–Prop trading had absolutely nothing to do with the financial crisis. Zero. The financial crisis was caused by credit problems, and prop desks are far too nimble to get hooked on illiquid nuclear waste.”

    Wrong!

    You must be new to this site. You have not read Barrys (the host of the blog) book or any of his posts on this blog over the past 5 years or at WAPO!

  25. DeDude says:

    @S J Morton;

    Liquidity will not drop sharply but it will be forced to come out of entities that are not FDIC insured and backed by tax-payers. By making it cumbersome and hard for FDIC insured banking entities to provide money for the gambling industry on Wall Street, that gambling industry will be forced to get money that is not backed by the government – and that is EXACTLY how it should be. It may reduce the amount of gambling and it may increase the cost of gambling – and that’s just fine with me. So lets at least close the door before we put another horse into the barn.

    We want independent brokers that are not banks to become more competitive and take away the gambling business from FDIC insured institutions. Since FDIC institutions have a huge competitive advantage we can only get that transformation done by either banning or making it cumbersome and difficult for the FDIC institutions to do the gambling. Death by a thousand cuts to the gambling by FDIC institutions sound like a good plan to me (although a Glass-Steagall bullet to the head would be a more rational approach).

    @Doofus; Yes Corporate persons are more equal than those made of blood and flesh.

  26. cynical says:

    Well written. I get the point but I disagree with the “boring 3-6-3″ stuff. Boring banks failed and overall it needs to be better stated. The utility part of a bank is moving money – sending wires and writing checks – not deciding how to invest your money to gain a return. After all you deposited your money in the boring bank for 3% right – not 2%. And making a 6% loan is speculative.

    Regarding prop trading – not all banks were similar. Read the UBS report. The prop desk was early to the game and got out sort of early and with smallish 2-3 billion loss. The flow CDO desk was responsible for the big 10s of billions losses.

  27. Julia Chestnut says:

    I also think that this would make an excellent WaPo feature. The more people understand the fundamental relationship here, the better. But furthermore, I genuinely believe that most all of the people who make policy and write/pass legislation simply have NO CLUE how these things really work. Not only did my mother advise me to “not ascribe to malice what can easily be explained by stupidity,” but I’ve stood around at parties and explained derivatives and securitization to Hill denizens, and the sheer staggering ignorance is palpable. They want to do the right thing, but the only information they are getting is from the wrong people.

  28. arthurcutten says:

    I certainly could not disagree with the primary theme of counterparty risk and the necessity of a Glass-Steagall rule.

    However I think the description of JPM’s role in the MF Global scandal is overly simplistic and a bit misleading.

    Soros may have merely been on the other side of the trade, and thus merely a patron of the clearing house.

    But JPM was also MF Global’s banker, and extended them a credit line on the very trades they were taking. And they also had an intimate knowledge of MF G’s finances.

    Do not forget that. It blows the casino analogy apart.

  29. machinehead says:

    Julia Chestnut: ‘I’ve stood around at parties and explained derivatives and securitization to Hill denizens, and the sheer staggering ignorance is palpable.’

    A Chinese idiom perfectly captures their facial expressions: ‘like ducks listening to thunder.’

  30. Bob is still unemployed   says:

    @BR says, “…We go through massive contortions to create an illusion that your money is yours, that its safe and sound in a bank with your name on it, in your own virtual safe deposit box. But that is simply not the reality of modern banking. What you perceive as “your money” is little more than an electronic journal on the banks accounting ledgers….”

    It is not just the banks that have this clever sleight of hand. Brokerages do the same thing with shares of stock. The brokerage customers believe they actually own the shares that are in their account. What the brokerages’ customers perceive as their shares are actually in the name of the broker, a.k.a., street name.

    So what does this mean? Well, one thing it means is that you do not own the shares, all you “own” is a brokerage’s promise to deliver the shares when you request actual certificates or decide to sell the shares.

    The question then becomes, if all the broker places in your account is promise to deliver the shares some time in the future, why should one think that the broker actually bought shares with the money you paid to the broker? The financial institutions wouldn’t do anything dishonest with their customers’ money, would they?

  31. cn-

    re..”Are you stoopid?”

    sometimes, but, wasn’t trying to be (above)..

    BR laid out..”…When the next bank blows up — note I said when and not if — their depositors will become counter-parties. Those depositors are you, just like MF Global’s. Only, you as counter-part are not first in line with a claim on the monies — the folks on the other side of the trade get first dibs…”

    which, I, too, see as accurate..

    that U$D ~100 bn on AAPL’s ‘Books’ is not, as you put it..”…Just think of AAPL as a $475B fund, that has a portion ($100B) of its assets invested in Treasuries…”, is it?

    but, then again, it doesn’t matter, does it?

    AAPL’s ‘Cash’/’Securities’ are held by Firms like MF Global/JPM/C/BAC, et al., no?

    AAPL, though, while not alone, faces “…risks and rewards (that) are, to use a big word, “asymmetric”…”, no?

    you were asking..”…Does that really sound so bad to you?…”

    Yes, it does, and, given the general tenor of ‘things’, I think I’d rather have..

    http://search.yippy.com/search?input-form=clusty-simple&v%3Asources=webplus-ns-aaf&v%3Aproject=clusty&query=Glencore+Xstrata+90+billion+merger

    for starters..~

  32. Greg0658 says:

    ok the no such thing as “Social Security Trust” did it :-| Apple Stock, Gold, MFGlobal .. all # representations of future work worth
    see:
    http://www.ritholtz.com/blog/2012/02/an-adult-approach-%e2%80%93-ii-defining-relative-real-value/comment-page-1/#comment-609973

    Glass Steagall was a working function to an extent .. how about a new 21st century system that laborering laborers build Cashy Credit Bits like Reserves

    a Social Security type net is the only thing that really works – the kids agree to provide for the parents when old & gray … ok – sure – the issue get foggy when you include dodge’ies

  33. cbjohn1 says:

    Your main premise is beyond reproach; a socialized banking system cannot exist in conjunction with a more free-market based approach. If anything the Volcker rule doesn’t go far enough in addressing this.

    Would MF Global have been considered either a commercial bank under Glass-Steagall or be subject to the proprietary trading restrictions under the Vlocker rule? My understanding is that they wouldn’t be subject to either.

  34. Greg0658 says:

    FIRE economy is so apt .. finance – insurance – real estate fraud

    sometimes I wonder how many people it would really take to make the world go round?

    main stream media (fleeting print & airwaves) you are interesting bling in good times – but required, NOT

  35. rickw says:

    this gets my vote for the best article of the year.

    I wish the main stream press would listen to BR more. Cancel that BR – you need to go on Jon Stewart.

  36. Stan Klein says:

    Beside bringing back Glass-Steagall, we need to tame the derivatives casino that has repeatedly produced incomprehensible idiocy and economic craziness. I think derivatives can be tamed by a fairly simple step: Require derivatives to settle in the security or commodity involved and not in its cash value on the date of settlement. That would mean that the outstanding derivatives could not exceed the supply of the security or commodity and that to get their money out the derivatives counter-party who got the security or commodity would have to go to the cash market. It would kill a lot of fees, but that might be a good thing.

    This would not hurt the producers and users of commodities. It would cut back on the huge profits from making side bets on the real markets and the kinds of manipulation that have the derivatives side bets affecting the real markets. That nonsense gave us several crises starting with the “portfolio insurance” crash of 1987.

    We need to get back to banking being as exciting as watching grass grow.

  37. DeDude says:

    @Julia;
    Excellent point. How can they do what is right, if they listen to the wrong people.

    @Stan Klein;
    “Require derivatives to settle in the security or commodity involved and not in its cash value on the date of settlement”. That is a great idea and would help getting the casino addicts out of places where they are doing a lot of harm.

  38. S J Morton says:

    No Gman I’m afraid it’s you who doesn’t know what “prop” is. Prop trading had nothing whatsoever to do with the financial crisis. If you disagree, give me some examples.

  39. S J Morton says:

    DeDude, I disagree vehemently on the liquidity issue. Market makers make markets in products for everything that is unlisted, and there’s an awful lot of that out there. The only way to “make a market” is to principal the transaction, which the Volcker Rule all but prohibits. If you take that role away from banks you will absolutely reduce liquidity, and dramatically so. The only way to avoid that would be to re-create the web of investment banks we had 10 years ago–GS, MS, Merrill, Bear Stearns, Lehman, Salomon, not to mention the commercial banks who began doing that like JPM, Chase, etc.

    Have Glass Steagall, sure, but the Volcker Rule is poorly conceived and hopelessly blind to unintended consequences.

    It also misses the point, and I repeat: Prop trading had nothing to do with the financial crisis.

  40. DeDude says:

    SJ Morton; It took a snap of a finger to merge investment banks with FDIC insured banks when everybody wanted that to happen. Why would it be so hard to demand that the uninsured iBanks be split out from the FDIC insured banking business as independent entities? I understand why the iBanks could not survive during a financial crisis but we don’t have a financial crisis anymore – so kick them back out on their own again. Yes they would have to pay more for capital, but that is only fair. Their current easy access to cheep capital is an abnormality that cannot be justified, because it is based on the explicit guarantee that they will be bailed out by taxpayers.

  41. S J Morton says:

    Yes DeDude I think that makes sense, but that’s not what VR does. It’s up to the banks to decide. Some (like Barclays) say they will give up their bank charter but how many? What will JPM do? How many I-banks will we be left with? We don’t have very many real market-makers as it is, and the VR will only make that smaller.

    It’s not easy to separate the two functions these days, so much of what is done is securitized. Can a deposit-taking institution paying zero on deposits and able to make maybe 25bp at the Fed be profitable? I don’t know, but I suspect not.

    Going back to the prop thing, it’s a red herring in a way, it’s not what needs to be addressed, which is the obsession of the VR. It was exposure to subprime–and the whole syndication and underwriting of the deals, with all the silly tranching etc–that killed the banks. Just like Europe today, it’s not prop, though Sarkozy’s heir apparent says it is. The banks loaded up on sovereign and foreign debt, and I can assure you, no prop trader does that sort of thing, not in any size anyway. That’s the senior layer of management that says, sure, let’s take on EUR 50 billion of Portugal. A prop guy would be lucky to take EUR 50 million.

    The real issue is that the banks are too big to fail. Citi and JPM are $2 TRILLION. That is just dumb. They need to split up or pay some sort of TBTF insurance, like Geithner has promoted.

  42. DeDude says:

    I don’t think the banks are supposed to make profit by the spread between deposits and treasuries. However, the spread between CD rates and mortgage rates should allow them a healthy profit if they hold the mortgages AND don’t do “stupid” loans. They are also supposed to lend money to solid small (and big) businesses, and that function also has plenty of spread to make money (again provided you don’t do stupid loans). Those are the kind of things that are important to society and that we want FDIC insured and well-regulated banks to do. We don’t need to “securitize” all these loans – in most cases securitization do more harm than good for society. It separates the negative consequences of giving out bad loans from the person (institution) that decide if the loan should be given. The suggestions that investors 3 links (and many a fee collection) down-stream) should be able to evaluate the actual risk, has in real life proven as stupid as it sounds. So the only thing securitization has been able to do is to hide the risk and increase the cost by adding fee collectors – not that useful for society.

    It may be that prop trading can claim to be innocent in the failure of banks, but that is not the question. At issue is whether gambling with depositor’s money (even at only 50 million per bet) should be FDIC insured or it belongs outside of FDIC insurance covered institutions. Personally I think that anything that is not about giving small loans to little people and businesses, belongs outside of FDIC insured institutions. Split up the big banks, and split up their functions at the same time.

  43. reedsch says:

    The high-wire investment banks converted to safety-net depository institutions at almost unheard-of speed. Seems all it takes for a fat-and-happy Capitalist to turn into a raving Socialist is for the wolf to arrive at his door.

  44. S J Morton says:

    That’s what I mean, DeDude, loans are very risky, certainly risky enough to bring down a bank. There is no restriction that I am aware of in the VR (and I’ve actually read the darn thing) that prohibits a bank from holding the kinds of assets that brought them down in ’07-’08.

    It’s a very tricky business. Yes banks are not lending, but that’s because they don’t like the risks they see, not because they’re making more money buying treasuries or whatever. Or they are too deposit-rich and don’t have the kind of customer base to make the loans. That happens all the time, so there is a wholesale market for these loans, or they’re syndicated and sold off. That’s the way the world has evolved. The old model of borrowing from someone on 17th street and lending it to a dry cleaner on 19th street is pretty much over.

    You do make a good point, that the securitization removes the bank from the credit risk aspect but I think that was more a function of the boom days of the bubble. Loans are routinely packaged and distributed for efficiency reasons, not necessarily because the bank plans to dump them on some unsuspecting sap. But with subprime that was the game, the stuff was nuclear and it was one big game of hot potato.

    In my opinion Volcker does not differentiate between what is true prop (a bunch of guys speculating with liquid assets who take risk but don’t endanger the bank) and what I would call proprietary lending–because let’s face it, it is. Any loan is “proprietary” but Volcker-safe. So is a CLO, CBO, and all the other CxOs, from what I can tell. It’s the credit exposure that killed the banks, and that risk has not been addressed by the VR. If you want to leverage up and lend to shaky enterprises, you can still have at it. That, according to VR, is safe, it’s not proprietary trading. And it’s sickeningly absurd.

    The only practical aspect of the VR is to decrease liquidity by severely restricting market-making. Yes that may lead to banks splitting in two, but it has not addressed the TBTF issue, nor has it limited the practices that brought us to the precipice in the first place.

  45. [...] TBP with a helpful reminder about the banking system [...]

  46. gman says:

    SJ Morten

    I own a prop trading firm. One that trades partners money. Not one that trades absentee shareholders or is FED/ FDIC backed. I have former Bear and LEH people at my firm. Many stories about how both of those firms had “prop trading” operations that made did well during the securitisation boom. Then the bids dried up for what they were making. These firm quickly left the “moving business” and went into the “storage” business.
    Prop trading at big systemically important firms played a big role in the crisis and to say otherwise is a matter of semantics.
    Read Barrys book also.

  47. gman says:

    SJ Morten

    Your point about size, is another way minimize the socialized to downside for the big players..rather than outright ban of “prop trading” at “banks”

  48. S J Morton says:

    gman you just proved my point, prop desks NEVER make anything, they trade!! You should know that. The operations that made those products that “dried up” have nothing to do with prop trading, and you know it.

    Shame on you. And learn to spell, it’ll strengthen your argument. Punctuation would be nice too.

  49. arthurcutten says:

    “Prop trading does not place banks at risk.

    Trust me on that.”

    Nick Leeson.

  50. victor says:

    1) BR: well written article, I also agree that it should get re published for wider readership

    2) if the Fed would increase the fractional reserves requirement this type of banks’ behavior would be tamed, but would that also slow down economic activity as the proponents of low fractional reserves claim?

    3) I understand the Volker rule only attempts to reinstate Glass Steagall partially and many critics of Dodd Frank say that it doesn’t go far enough toward re-instating a firewall between customers’ money and the banks’ investments

    4) BR: isn’t the problem global? The largest banks/financial institutions are foreign (French, British, Chinese, Japanese, Swiss, etc). Do we (that is us, the suckers) need a global solution?

    5) Even with Glass steagall in place, would the reg’s work with the private equity firms (shadow banking) who could all by themselves bring about FinCrisis2.0? just asking.

  51. Francois says:

    Doesn’t Obuster realize that his constant bending over to the banksters could truly destabilize this country in a very ugly way in case of another bank blowup?

    WTF does this guy want?

    An opportunity to unleash this humongous National Security Industrial complex that he so eagerly financed, upon us?

    Unreal how fast and deep this country has tumbled since I came here 15 years ago.

  52. 873450 says:

    I believe in Segregrated Accounts + I believe in Chinese Walls =
    I believe Santa Claus gives toys to good children and rocks to bad children.

    To be fair, Volcker originally recommended breaking up TBTF and an updated, reinstated Glass Steagall.
    “We need to break up our biggest banks and return to the basic split of activities that existed under the Glass-Steagall Act of 1933 — one highly regulated (and somewhat boring) set of banks to run the payments system, and a completely separate set of financial entities to help firms raise capital (and to trade securities).”
    http://economix.blogs.nytimes.com/2009/12/17/paul-volcker-finds-a-hammer/

    After his initial advice was rejected, Volcker produced a 3-page document proposing strict regulatory oversight separating FDIC protected banking from unprotected in-house risk-taking speculation. When Dodd-Frank went to Congress the “Volcker Rule” was 10 pages. It then grew to 300 pages and has since been disavowed by Volker.
    “I don’t like it, but there it is, … I’d write a much simpler bill. I’d love to see a four-page bill that bans proprietary trading and makes the board and chief executive responsible for compliance. And I’d have strong regulators. If the banks didn’t comply with the spirit of the bill, they’d go after them”
    http://www.nytimes.com/2011/10/22/business/volcker-rule-grows-from-simple-to-complex.html?pagewanted=1&_r=1

  53. Sechel says:

    Great post, however in MF Global it’s beyond the issue of segregated accounts. Money was stolen.

  54. S J Morton says:

    arthurcutten,

    Leeson wasn’t a trader, he made unauthorized trades. Barings went down due to a failure to supervise.

    But let’s assume he was a trader and he brought down the bank. As an exercise I suggest you add up the banks that collapsed due to credit problems, and banks that collapsed due to trading. You will find that credit killed thousands, if not tens of thousands, of banks (including Lehman and Bear Stearns), while you can count the banks down by trading on one hand, and maybe one finger.

    Despite that, conventional wisdom says credit is good, and prop trading is bad. The Volcker Rule goes after prop trading which had nothing to do with the financial mess, and as a result raises bank costs, concentrates rather than diversifies their business lines, and restricts liquidity–which you and I will pay for, directly, through higher-priced banking.

    The real problem with the Volcker Rule is that people think it has addressed the problem, but it has not, it has exacerbated it. Banks will still be too big to fail, and they will still be able to invest in the products that brought them down. Go figure.

  55. pcbeck says:

    Not to be too simplistic here but what is an individual to do with their money to be safe? Where can I put my trading accounts that can’t be pillaged by the broker? Please help!

    ~~~

    BR: Custodians where there is no competing proprietary trading — we use TD; but I assume Schwab and Fidelity are safe as well. Note that E*Trade dabbled in derivatives and sub-prime and are not on my preferred list

  56. Tyler K says:

    Good post Barry.

    In relation to:

    “We go through massive contortions to create an illusion that your money is yours, that its safe and sound in a bank with your name on it, in your own virtual safe deposit box. But that is simply not the reality of modern banking. What you perceive as “your money” is little more than an electronic journal on the banks accounting ledgers….it is not as if your money is sitting in an account waiting for you — you merely have a claim on those monies”

    The very first thing I thought of was Jimmy Stewart’s infamous explanation:

    “… You’re thinking of this place all wrong; as if I had the money back in the safe. The money is not here … Why, your money is in …”

    http://www.youtube.com/watch?v=_Er69b4HMl8

  57. pcbeck says:

    BR – thanks for the response. What if you trade futures?

  58. jstratton says:

    Thank you for an excellent article!

    I have been much troubled by the MFGlobal theft. To me it dramatically raises the risk of investing. I am shocked by how few people seem to see how important an issue this is. I do wonder if the dramatic decrease in trading volume on stock exchanges isnt connected to this issue.

    How safe are retirement funds that people count on when they can be stolen?

    Now that the rules of the game have changed, consider how massive entities can begin to manipulate markets. Isnt it going to be a sport to exploit the weak institutions like never before?

  59. itsbilly says:

    QQ: Are credit unions subject to the same vulnerabilities as the banks?

  60. [...] show – Washington Post Gold Demand Hits New Record Highs as Europeans Stockpile – CNBC MFGlobal Reveals You Are A Bank Counter-Party – The Big Picture Counterfeiting and American Monetary History – Uneasy Money The Grand [...]

  61. [...] your bank wants to screw you: “MFGlobal Reveals You Are A Bank Counter-Party” by Barry [...]