The Significance of Banning Proprietary Trading

The Significance of Banning Proprietary Trading

by Elliott R. Morss, Ph.D.

 In earlier articles, I have said that depository institutions should not trade – too risky. It was trading that led to the bank collapse when there was suddenly no market for asset-backed securities. I have also argued that banks should not be allowed to dump their loans into a secondary market for a commission. Instead, they should have to manage their own loans. My way of getting this to happen? Limit FDIC insurance to banks that comply.

 Much to my surprise, there now appears to be some support for the trading restriction.

• Barney Frank said the following in a recent e-mail: “I am a supporter of the proposal by Paul Volcker, which the President embraced, to ban proprietary trading by banks.  In fact, before Mr. Volcker got the President’s support, I backed an amendment in the committee that I chair that specifically empowers the regulators to ban proprietary trading by depository institutions, and since the Obama administration has clearly indicated support for that, the effect of that amendment – which passed over Republican objections – would be to allow that ban to go into effect as soon as the bill is passed.”
• When Volcker first made his proposal, Summers and Geithner tried to marginalize him. But recently, it does appear that Obama is coming around, and Volcker is back to center stage.

 In understanding what this would mean, it is important to distinguish between depository institutions, e.g., Citi and Bank of America and non-depository financial institutions, e.g., investment banks, hedge funds, private equity companies. The ban would only apply to the depository institutions. A ban on proprietary trading would mean that banks could not trade on their own account. They would still be able to manage other people’s money by buying and selling financial securities, but no buying and selling of their own assets.

 A ban on proprietary trading would have great significance – it would take us back to where we were in 1933 when the Glass-Steagall Act required depository institutions to stop all buying and selling of equities because it was deemed too dangerous an activity for banks.

 Such a ban would mean the best paid people in depository institutions – risk takers – would have to find new jobs. Don’t feel sorry for the risk-takers: there will always be a market for “risk adjusters:”for more on this, see my article on the road map of global finance. And remember that within limits, risk adjusting is a valuable activity.

 What are the chances such a provision will be included in the final bank regulatory bill? Not good, but improving. Why are the chances not good? Forget about what would be good for the people: DC is mostly run by the special interest groups, and the financial industry will fight it (in the 2008-9 period, the industry spent almost $1 billion on lobbying).

 But the outrage over the financial industry is growing. On this subject, I close with a quote from Frank Rich’s piece in last Sunday’s New York Times:

Even if the reform bill does bring stringent regulation to derivatives — a big if — that won’t rectify capitalism’s worst “innovation” in our own Gilded Age: the advent of exotic, speculative “investments” that have no redeeming social value and are instead concocted to facilitate gambling for its own sake. Such are the Goldman instruments of mass financial destruction that paid off for John Paulson. In 2007 alone, according to Gregory Zuckerman in his book “The Greatest Trade Ever,” Paulson’s personal take amounted to over $10 million a day, “more than the earnings of J. K. Rowling, Oprah Winfrey and Tiger Woods put together.” That “financial alchemy,” as Zuckerman calls it, explains why the finance sector’s share of domestic corporate profits, never higher than 16 percent until 1986, hit 41 percent in the last decade.

As many have said — though not many politicians in either party — something is fundamentally amiss in a financial culture that thrives on “products” that create nothing and produce nothing except new ways to make bigger bets and stack the deck in favor of the house.