Tuesday, May 22, 2012

Volcker on Derivatives and Trading

Here's some of what Paul Volcker had to say in front of the Senate Banking Committee (Subcommittee On Consumer Protection) earlier this month:

The newly enacted prohibitions on proprietary trading and strong limits on sponsorship of hedge and equity funds should be much more significant. The impact on the sheer size of the largest U.S. commercial banking organizations and the activities of foreign banks in the United States may be limited. They are, however, an important step to deal with risk, conflicts of interest, potentially compensation practices and, more broadly, the culture of banking institutions.

The justification for official support and protection of commercial banks is to assure maintenance of a flow of credit to businesses and individuals and to provide a stable, efficient payment system and safe depository. Those are both matters entailed in continuing customer relations and necessarily imply an element of fiduciary responsibility. Imposing on those essential banking functions a system of highly rewarded – very highly rewarded – impersonal trading dismissive of client relationships presents cultural conflicts that are hard – I think really impossible – to successfully reconcile within a single institution. In any event, it is surely inappropriate that those activities be carried out by institutions benefiting from taxpayer support, current or potential.

Similar considerations bear upon the importance of requiring that trading in derivatives ordinarily be cleared and settled through strong clearing houses. The purpose is to encourage simplicity and standardization in an area that has been rapidly growing, fragmented, unnecessarily complex and opaque and, as events have shown, risk prone.

There is, of course, an important legitimate role for derivatives and for trading. The question is whether those activities have been extended well beyond their economic utility, risking rather than promoting economic growth and efficient allocation of capital.

The battle over things like "Volcker Rule" and related continues but I think it is a good idea to listen to what Volcker has to say unfiltered.

Here are some related articles:

Volcker Defends a Rule Bearing His Name

Four Years After AIG, Wall Street Back to Its Old Tricks

JPMorgan's soap opera

For Some, Disaster Is Spelled CDS

Don't Save The Whales

Considering the scale, complexity, what's at stake, and the entrenched interests involved (and the mess that it is), I think how long it is taking to resolve these issues is hardly surprising.

Adam

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