Finally, Something I Can Agree With Citigroup About!

No surprise here: As the deadline approached for comments on the "Volcker Rule" provision of the Dodd-Frank financial reform legislation letters poured in from banks and other financial institutions telling regulators that if the Volcker Rule is passed as it's currently written, rivers will turn to blood and a rain of evil, rabid frogs will darken the skies.

Ok, so they didn't put it exactly like that, but The Wall Street Journal summed up Goldman Sachs' (NYSE: GS  ) letter as arguing that:

… the rule underestimates the complexity of the financial markets, diminishes the role of banks in making money flow around the world to companies and countries, and could wind up causing banks to lend less and charge more for their services.

Goldman joined a chorus of banks that included Morgan Stanley (NYSE: MS  ) , which declared that the "list of undesirable consequences is long and troublesome" and Bank of America (NYSE: BAC  ) , which warned that the Volcker Rule "is rife with unintended consequences, many of which would undermine the safety and soundness of U.S. banking entities and U.S. financial stability."

Citigroup (NYSE: C  ) , meanwhile, had many of the same dire warnings for regulators, but what caught my eye in its letter was Chief Risk Officer Brian Leach writing:

… the proposed rule is complex, with overlapping and imprecise compliance requirements, and does not provide sufficient clarity as to what type and level of activity is permissible, which itself may impair capital markets.

To which I say, "Amen, Brian!"

The fact is that the Volcker Rule is complex and is unclear in many areas. Loopholes abound in the rule, particularly as it pertains to market making, which is allowed under the Volcker Rule. That alone creates big questions for banks in terms of what is truly market-making and what slides over the line into proprietary trading. The best answer may be the simplest of all, but hardly the one the Citi's Leach had in mind: Remove market making from the banks' business model as well.

In its extensive and well-written comment letter on the Volcker Rule, Occupy the SEC quoted Nobel Prize winner Myron Scholes:

[A] leveraged market-making business is inherently unstable.  Banks might be the wrong providers of liquidity to markets.  Simply put, leverage can only be reduced by selling assets to raise cash if market makers are making markets in the assets they need to sell and they no longer can continue to do so at times of shock and to make conditions worse, they borrow from each other with short-term financing to hold longer-maturity relatively idiosyncratic assets.

It would also seem to fit with Volcker's original intentions in championing the Dodd-Frank provision. In his own comment letter on the issue, Volcker reminded regulators of the spirit behind the rule and the Dodd-Frank legislation as a whole.

The basic public policy set out by the Dodd-Frank legislation is clear: the continuing explicit and implicit support by the Federal government of commercial banking organizations can be justified only to the extent those institutions provide essential financial services. A stable and efficient payments mechanism, a safe depository for liquid assets, and the provision of credit to individuals, governments and business (particularly small and medium-sized businesses) clearly fall within that range of necessary services. [Emphasis Volker's.]

Not that the banks should be blamed for arguing vehemently against the Volcker provisions. Trading is a seriously profitable activity for the major banks and the regulation seriously threatens that cash cow. The extent to which trading-related activities have taken over the banks is astounding and nowhere is it on display in higher relief than at Goldman Sachs.

Though Goldman recently started breaking out its business segments differently -- which makes it a bit more difficult to isolate trading (wink, wink) -- in 2009 trading and principal investments accounted for a staggering 87% of the company's total pre-tax profit. Back in 2000, the year after the company first went public, that arm made up less than a third of pre-tax profit.

The golden tongues of those in big banking have accomplished a lot in the past couple of decades to make banks far larger and more profitable, but at the same time they've created a riskier system as a whole. As the Volcker-Rule comment letters suggest, the banks would like us to continue to act like Stockholm-syndrome sufferers, deferring to the godly judgment of our "too big to fail" kidnappers, who, for understandable reasons, have their sights set on big profits and absurd bonuses.

But after decades of deregulation that did little to prove anything except the fact that the former regulations were pretty smart after all, it seems high time that we put a little less stock in how highly-paid bankers think that banks should be regulated.

Citigroup's Leach is correct, the Volcker Rule -- thanks to lobbyist wrangling and the watering-down of the provision that's already taken place -- is complex and often unclear. Let's simplify it and make it clear. Let's make banks simple and clear. Let's make them once again into safe, boring deposit-taking institutions that don't think they can hold a gun to the entire global economy's head.

That, of course, won't happen. But as the Volcker Rule approaches the currently-slated implementation date in July, we'll get a chance to see if there's any spine at all left in financial regulators.

Fool contributor Matt Koppenheffer owns shares of Bank of America and Morgan Stanley, but does not have a financial interest in any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.

The Motley Fool owns shares of Bank of America and Citigroup. Motley Fool newsletter services have recommended buying shares of The Goldman Sachs Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.


Read/Post Comments (8) | Recommend This Article (15)

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  • Report this Comment On February 16, 2012, at 9:42 AM, Usurped wrote:

    "But after decades of deregulation that did little to prove anything except the fact that the former regulations were pretty smart after all, it seems high time that we put a little less stock in how highly-paid bankers think that banks should be regulated."

    The author's credibility on a fairly narrow issue, has been blown up w/ a massively reflexive, w/o supporting evidence bare naked screed. Congrats!

  • Report this Comment On February 16, 2012, at 4:52 PM, DJDynamicNC wrote:

    Yes, nothing says "screed" like noting that banks sorta-kinda screwed up once the rules were changed to give them the ability to sorta-kind screw up in that paticular fashion, which had been prohibited to them previously because they had in fact sorta-kinda screwed up in exactly that fashion before.

    Load up the brimstone, this polemic is just getting started!

  • Report this Comment On February 16, 2012, at 5:38 PM, slpmn wrote:

    The dirty little secret about mega-banks is they really aren't very good at banking. So they rely on things like debit card interchange fees and trading for their revenue because if they relied on old fashioned spread lending to consumers and businesses, they'd go broke. Thousands of community banks eat their lunch every day when it comes to going out and making profitable loans to small businesses. Our economy depends on the giants only in the sense that if the fail, they bring everyone down with them.

    The sad sad reality is, if they couldn't be broken up after the disaster of 2008, it's unlikely to happen in our lifetimes. They will cry and whine and donate money to politicians, and like Veruca Salt, they will get their golden goose.

  • Report this Comment On February 16, 2012, at 11:01 PM, devoish wrote:

    I've been reading through Occupythesec's responses.

    I like them. To me their suggestions seem to separate gambling and banking. It is clear they worked hard to publish that 300 page response and I ma truly thankful that someone outside the investment banks has contributed.

    I have very little hope that suggestions from citibank or jpm will do anything but accelerate the economy into their own pockets.

    Best wishes,

    Steven

  • Report this Comment On February 17, 2012, at 12:16 AM, TMFKopp wrote:

    @devoish

    "I've been reading through Occupythesec's responses. I like them."

    I've been a bit skeptical of the Occupy movement all along, but the folks at Occupy the SEC definitely provide a big dose of credibility. That's a very well-written and thoughtful comment letter.

    Matt

  • Report this Comment On February 17, 2012, at 12:28 AM, Merton123 wrote:

    Matt makes a good point about the former Glass Steagal act that was put into place after the Great Depression. The act created two types of Banks - one that could make markets and the other commercial banking.

    I am surprised that the regulators just didn't bring back the Glass Steagal act.

    Both the Bush Administration and Obama administration did the right thing they kept the capital markets liquid thereby avoiding another depression.

    We may have another credit crunch in 20 years when the next generation of bankers take control. Hopefully the administration of that time will respond in a like manner as Bush/Obama did

  • Report this Comment On February 17, 2012, at 6:00 AM, JacksonInVA wrote:

    Anything Goldman Sachs dislikes, I like. They are thieves and criminals.

  • Report this Comment On February 17, 2012, at 8:53 AM, ET114 wrote:

    1st off, I'm IT guy, certainly no financial wizard... major US financial institutions are anything but "banks"... The major issue is: Their boss, The Fed has a major scam going with them... They are the major buyer of US (Fed) notes and bonds; China and other foreign countries are NOT the majority holders of US debt... We The People are... US financial institutions, etc. buy the debt scheme; the collateral is our $$$ in the bank, savings, 401K, IRA, etc... So, all the blah, blah, blah regarding the Volcker Rule misses the primary issue... The unlawful scam by the Fed using We The People's money in banks to back the US Gov't debt. Sure hope Humpty Dumpty stays on the wall...

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