• The single best thing we could do for financial reform: Triple the budgets of all financial regulatory agencies. Immediately. Regulators are woefully understaffed; this is fact.
  • Obama has proposed banning banks' prop trading desks and internal hedge funds. I'm fine with that, as long as it's done properly. From a P&L perspective, this is obviously bad for the Street. From a public policy perspective though, there's really no compelling reason why the banks need to have prop trading desks or internal hedge funds.

    But you can't simply prohibit banks from buying and selling securities for their own account, because that's precisely what market-makers do. Market-makers have to stand ready and willing to buy or sell securities for their own account, at firm bid and offer prices. If an investor is looking to sell a security, the market-maker will buy the security using its own capital, and hold it in inventory until an investor who's looking to buy the security surfaces. This is different from having a prop trading desk, which has no market-making obligations, and essentially acts as a hedge fund (except it has the not-insubstantial advantage of being inside the prime broker).

    Some people will claim that it's impossible to distinguish between market-making trades and propietary trades, but that argument is completely baseless. The banks themselves already distinguish between their market-making trades and their proprietary trades, as there's a whole different set of rules for proprietary versus market-making trades. So don't be fooled by that argument.

    In any event, I don't even know why I took the time to write about this, because there's zero chance the proposals Obama announced today will ever be law. This was a fairly transparent political stunt — the White House needed to do something to take the media's focus off of health care 24/7, so they flew in Volcker and announced some proposals that sound good to the media. The two Senate staffers I talk to regularly both said their offices were basically ignoring Obama's proposals, because even if the White House fights for them (which they won't), Chris Dodd has no intention of inserting them into his committee's bill. I like how some people think Obama's proposals represent a fundamental turning point on financial reform, because....well, clearly this is their first rodeo. (Hence the uber-quixotic language they use to describe financial reform.)

    [Update: Just to clarify, when I said Obama's announcement was a "fairly transparent political stunt," I wasn't criticizing the Obama administration. We live in a political world, and political stunts are often useful. If I were Rahm Emanuel, I'd be a dick have done the same thing. I think it was probably a savvy move, and if health care reform ends up passing, then it was worth it.]
  • This, from John Taylor, is just sad:

    "[N]ot one counterparty, derivative counterparty to Lehman, filed for bankruptcy after the Lehman case. The major creditors who did not fail. So it's hard to find a direct knock on effects from that in the data."
    What?! First of all, Lehman's biggest derivatives counterparties — the other dealers — were virtually all bailed out by their governments. Second of all, there were lots of hedge funds that failed because of their open derivatives positions with Lehman, and especially with Lehman Brothers International (Europe). The fact that John Taylor didn't know about these hedge fund liquidations at the time doesn't mean they never occurred. They occurred. Oh believe me, they occurred.

23 comments:

David Smith said...

Just so. Not only is this their first rodeo, they don't seem to know anyone who has ever seen a horse before.

Minor cavils: I'm not sure something like this won't become law. The Obama team needs a win, and I can't see Republicans squandering their new political capital defending Goldman Sachs. And I think even the media Amen corner finds this transparently political and likely ineffectual if it doesn't actually blow up in the administration's face. Mort Zuckerman's tirade in the Daily Beast probably says what many elite media types think.

Barry said...

"The Obama team needs a win, and I can't see Republicans squandering their new political capital defending Goldman Sachs."

The GOP will not 'defend' G-S, or any other Wall St firm. They will attack 'Evil Librul Job-Killing Socialism, which Collapsed the Bush-conomy'. And after watching 'keep government out of my medicare' signs this last summer and fall, they'll be successful.

Remember, the big money is in Wall St; it'll defend itself. And the MSM will support the big money.

Barry said...

I agree that the Obama team needs a win, but they're pretty clueless about how to get one, starting at the top. I really think that Obama did not think that the GOP would have and maintain a strategy of 100% obstruction. He also didn't seem to have a clue as to what to do when his alleged 60-senator block turned into 40-odd senators + a bunch of backstabbing b*stards.

Barry said...

Oh, about the John Taylor BS - somebody pointed out that economics is a field where, to find stupid or lying BS, one can fill one's basket in the elite departments. One doesn't need to go to AIE or Heritage or....Hoover; one ca find all of the crazy, lying and batsh*t insane one needs in the top 10 departments. Without looking hard.

Anonymous said...

For what will this frightened congress vote? They're running scared. They are going to guess, vote for the guess, and hope for the best. First off, Bernanke is going down. Obama will have to find a Main Street alternative, and none, other than straight-up idiots, exists.

Joseph Stiglitz to head the Federal Reserve? Lol.

wjd123 said...

"In any event, I don't even know why I took the time to write about this, because there's zero chance the proposals Obama announced today will ever be law. This was a fairly transparent political stunt — the White House needed to do something to take the media's focus off of health care 24/7, so they flew in Volcker and announced some proposals that sound good to the media. The two Senate staffers I talk to regularly both said their offices were basically ignoring Obama's proposals, because even if the White House fights for them (which they won't), Chris Dodd has no intention of inserting them into his committee's bill. I like how some people think Obama's proposals represent a fundamental turning point on financial reform, because....well, clearly this is their first rodeo. (Hence the uber-quixotic language they use to describe financial reform.)"


Wow, talk about an attempt to dampen expectations. It's not going to work. People want change. Frustrate their expectations and they will just come back all the angrier.

"Economics of contempt" should spend less time talking to senate staffers and more time to people who have never seen a rodeo and don't care. I say this because he believes that this is some kind of scheme dreamed up by the White House for political reasons. I don't believe it; I believe Obama means what he says.

Yesterday Obama recruited Anger in his fight against the financial industry. He can only channel it and he can only channel it in a way that doesn't frustrate its expectations. That's a different kind of rodeo, which I suspect financial lawyers and senate staffers are about to learn they can turn off or ignore.

If today, Anger is fighting for reform with pitchforks, frustrate it, shut the gates on it, and Anger will be back with the battering ram, and battle axe.

When the gates to real reform fall and anger has its day. It will no longer just be looking for victory but vengeance. And when the financial community and its congressional allies asks for quarters they will get none.

It doesn't make any difference if Dodd is interested in Obama's reforms or not. It doesn't make any difference if he doesn't feel the pressure because he won't be running for the senate. It doesn't make any difference because if Angers expectation can't be dampened his fellow senators will feel the pressure. If the choice is between letting Dodd retire to a cushy job in the finance industry or saving there own skins. Dodd is toast.

That is why it is important that any attempt to lower expectations should be resisted.

Kid Dynamite said...

"Some people will claim that it's impossible to distinguish between market-making trades and propietary trades, but that argument is completely baseless. The banks themselves already distinguish between their market-making trades and their proprietary trades, as there's a whole different set of rules for proprietary versus market-making trades. So don't be fooled by that argument."

you sure about that? i think that's exactly the problem. there is a very fine line between principal and proprietary. i know you read my recent post - i'd be curious as to what you thought of the few examples i laid out regarding this fine line.

Anonymous said...

The MSM will rush out in defence of Wall Street? Who do you think is whipping up all the hysteria about the bonuses? Or about "evil" Goldman Sachs who dared to make a profit and is daring to reward people for success?

Stay off the crack man, just say no...

Danny

Economics of Contempt said...

Kid Dynamite,

Well, obviously I can't vouch for every single bank, and a lot happened during my 2 years on the beach, but I'm quite sure that several major dealer banks distinguish internally between market-making and proprietary trades. How rigorously each bank enforces this is another matter (and obviously it varies widely, as all things like this do). The point is that the banks' legal departments have already proven that it can be done.

I'm not saying it's not difficult to distinguish between market-making and proprietary trading -- obviously, it is. I'm just saying that it's certainly not impossible. I'd seen several people say that it's flat-out impossible to do -- mostly in a half-mocking, "oh they just don't understand" way -- and that's total crap. Now, are there going to be situations where the difference is quite subtle, and accurate line-drawing is going to be difficult? Sure. But we engage in line-drawing like this all the time, and, in fact, several major banks do it themselves already. (I remember when we had this debate back in '97/'98 when the SEC was designing the "Broker-Dealer Lite" rules.)

I'll definitely try to address the examples you gave in your post, as you obviously hit on the most difficult situation (that is, when a market-making desk takes a position that it anticipates will be customer-related and will only be held for a short amount of time, but for whatever reason ends up becoming a long-term position.) But since I just made it home from a trip, and I'm pretty tired, it'll have to wait until tomorrow.

Kid Dynamite said...

EOC - funny, i've been on the beach for two years also.

in all my time on the trading desk, we never distinguished between market making and proprietary trades. COULD WE? usually - of course WE knew - but that doesn't mean any regulator could ever enforce that. and then again, there are always trades that walk the line between prop and principal.

It's conceivable that every trading desk could have a regulator who would oversee them and sit down at the end of the day in a trade recap meeting and make them explain each and every trade - but not practically feasible.

the important thing is that the populace gets EDUCATED so they aren't so angry. It's actually pretty hard (And rare, i'd say ) for the big b/d's to frontrun their customers - all the data is captured and easily compared - even the NYSE and the SEC makes inquiries along this front. Never mind the fact that the traders at the real firms simply don't need to take this risk of getting cuffs slapped on them - i've never met one who did.

Similarly, it's important for people to understand that the b/d's are in the money making game, not the money management game (see the whole GS client disclosure letter when they said they may have positions in trading ideas). Once we put aside all the uninformed anger, we can get past the populist reactionary policies, and try to fix what's actually wrong, which, in a word, is leverage.

Anonymous said...

wjd123 and the traders will leave for foreign shores in the far east. I left the UK nearly 5 years ago and never ever regretted it. I mainly only read about the changes the UK and US are making to cheer myself up!

I will ask you the same question i ask the other angry men... you planning to make up the tax the banks brought in all these years? You personally going to lend to all the sub-prime borrowers who got a house they otherwise wouldn't have got?

Danny

anne said...

"The important thing is that the populace gets EDUCATED so they aren't so angry. "

I'm not sure it's the population that needs the education. What Wall Street does not seem to understand is that until the bailout, no one cared really HOW they made money on Wall Street - no one really much cared about the bonuses or the massive golden parachutes the leaders got, regardless of performance.

And then the bailout happened.

What has upset the residents on Main Street is that whatever way they traded over there on Wall Street was done in such a way as to require a massive government bailout "or else the economy would collapse," or so Henry Paulson informed us in September 2008.

Profits made in the years up to the crash belonged to the banks - the losses the same banks acquired in that same run up the hill (and off the cliff) became the property of the US government.

So to salvage the economy, we made the move to privatize profits and socialize loss for some of the wealthiest companies in America. That's a really bastardized version of capitalism we've got going these days.

Now, if the the bailout had resulted in economic growth outside of Wall Street, if unemployment had been halted by TARP, again, I don't think any one would have cared much about how they run their shops over there on Wall Street - or about their bonsuses.

That's not what happened. The economy tanked. Unemployment skyrocketed. (There's a report issued by the Brookings Institute the day before GS's quarterly statement was released that says 30 percent of Americans are now living below the poverty level. 30 percent!

You can access that report here:
http://www.brookings.edu/papers/2010/0120_poverty_kneebone.aspx)

People aren't stupid. They're unemployed. They're poor. And they're growing unwilling to stomach the idea that our government and our economy exists to provide profit and absorb losses for the financial sector.

Kid Dynamite said...

great points, anne, and i agree with you. my point is that Wall Street exists to make money. it's important to realize that - it's not about charity, and it's not about the good of society. Thus, we need to hold the people responsible for these ill advised bailouts accountable - those are the congressmen who voted for TARP, and yes, Hank Paulson for ramming it through. TARP/EESA was enacted with little forethought of the consequences, and now the administration is trying to impose populist solutions after the fact - which almost never works to solve the problem.

I've written at length about the concept of "don't hate the player, hate the game." Don't expect GS to change their stripes - they exist to make money (although i'm pretty surprised that they set aside zero dollars for comp out of their 4th quarter, yielding to populist anger it appears) - so you need to remove the feeders - the Dodds and Franks of the world (who enacted the horrible legislation) - from the equation.

Anonymous said...

anne, no one cared when there was a bubble. No one cared when anyone could get a mortgage for anything,when you could refinance to buy any amount of tat. All they demanded was more of the same.

What seems to have been lost in all this is WHY these products were so popular and that is because YOU the retail investor looked at the very short term looking at the return and not the risk, an attitude that flows through into the mutual funds and pension funds who bought the products. Most funds that were more prudent in this time got killed, the ones who filled their boots got more inflows.

I find it extraordinary you have such ill-informed bile for GS. GS was pretty much the ONLY investment bank that DIDN'T need a government bailout. As far as I can tell you seem to simultaneously believe that they made lots of profits "immorally" at the same time as losing lots of money. I can only salute your ability to be so illogical.

As usual, it is the onion who expresses the "anger" you feel:

http://www.theonion.com/content/news/recession_plagued_nation_demands

See you moaning again after the next bubble bursts...

Danny

anne said...

"The single best thing we could do for financial reform: Triple the budgets of all financial regulatory agencies. Immediately. Regulators are woefully understaffed; this is fact."

EoC - are you saying some bankers have acted in violation of existing regulations but avoided penalties because underfunded/understaffed regulatory agencies didn't have the capacity to deal with the violations?

And Danny, You really think the retail investor's focus on short term gains is the root of this crisis?Who got bailed out? And why? (It wasn't the retail investor.)

What's illogical about expressing concern that our financial sector exists today (and yes, that includes Goldman Sachs) only because of a massive federal bailout?

Anonymous said...

"What's illogical about expressing concern that our financial sector exists today (and yes, that includes Goldman Sachs) only because of a massive federal bailout? ..."

In isolation, it most definitely does not include GS.

In the global sense, Main Street and Wall Street still exist because of the bailout, and that includes Goldman Sachs and Anne.

I totally disagree with KD that the bailout was ill-advised.

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Nicolas said...

"From a public policy perspective though, there's really no compelling reason why the banks need to have prop trading desks or internal hedge funds."

A bank might have an expertise on something that can be monetized. They dont want to give it away, so they do prop trading.

From a public policy perspective, obviously, that should not endanger their other activities.

Anonymous said...

re: Hedge fund BKs due to Lehman BK.

"They occurred. Oh believe me, they occurred."

Links please...this is the internet.

Anonymous said...

I really hope the financial reform gets solved properly. I was talking with some Broker Dealer Lawyers and they made me feel good about the future of the financial state.

Thanks for your great assorted thoughts and I really appreciate your insight.

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