The Dirty Games That Banks Play

My hat is off to the big banks and their lobbyists. I am in awe -- in amazement -- and truly and terribly frightened all at once after witnessing the havoc they've wreaked on the Volcker Rule.

The rule, some might recall, seemed all but a slam dunk following the worst financial crisis since the Great Depression. Bank of America (NYSE: BAC  ) , Citigroup (NYSE: C  ) , JPMorgan Chase (NYSE: JPM  ) , and Goldman Sachs received billions in taxpayer-backed bailout funding as their risky trading activities came around to bite them in the butt. The Volcker Rule was aiming to essentially repeat -- in an admittedly small measure -- what regulators did after the Great Depression. That is, get banks out of the risky, fast-dealing investment business and have them focus instead on... wait for it... banking.

As it appears right now, it wasn't to be. And to see the extent to which legislators and regulators appear positively toothless in the shadow of these banking giants makes me want to just go ahead and bow down to our banking overlords and get it over with.

Don't get me wrong; I very much appreciate the important role that banks play in our -- and the global -- economy. And my preference is to not be alarmist. But we're looking at very sensible legislation here -- a 2010 CFA Institute survey (opens a PDF file) showed 68% of respondents supported "proposals to separate proprietary trading and insured commercial banks." Not to mention the fact that the rule's namesake was one of the savviest Federal Reserve chairmen that we've had in this country. So it's not as if these are loony ideas lobbed by some out-of-touch, know-nothing outsiders.

Full-court press
As I outlined last week, a key rallying cry for the banks has been the complexity of the rule. However, that complexity arose as a result of the banks' original lobbying efforts to combat the rule. Bending over backwards to appease the "oh yes, they're still too big to fail" banks, regulators turned what was a simple legislative effort into a bloated, murky quagmire where we're suddenly expected to see the on-the-fly judgment of regulators shine. It's hard to feel confident when that judgment failed miserably not five years ago.

Perhaps we could credit lawmakers with the fact that banks couldn't kill the rule outright, but as ProPublica's Jesse Eisinger put it:

[The banks] couldn't kill the rule. Instead, they are getting Congress and regulators to render it morbidly obese and bedridden.

Oh yeah, there's more
The death-by-complexity approach is bad enough. But, as a Bloomberg report pointed out yesterday, this is a true multi-faceted attack:

U.S. banks pushed regulators to widen proposed restrictions on trading and hedge-fund ownership by foreign firms, then encouraged governments around the world to complain about the rule's reach. ... The two-pronged lobbying strategy resulted in foreign officials joining U.S. lenders to push back against the Volcker rule...

Essentially, banks -- in particular JPMorgan and Morgan Stanley (NYSE: MS  ) -- whined to the Federal Reserve that the Volcker Rule would put U.S. banks at a disadvantage to large foreign banks (like UBS (NYSE: UBS  ) , Credit Suisse, and Deutsche Bank). The rule that was eventually presented took the very overstepping-its-authority approach of trying to apply the rule to all of any foreign bank that had any presence in the U.S., not just its U.S. arm. It was an approach that was bound to bring heat from banks and governments outside of the U.S. that had no interest in having finance rules dictated from afar.

At the same time, banks turned up the volume on foreign opposition by "alerting" foreign countries that the only proprietary-trading exception was for U.S. Treasuries. More from Bloomberg:

The exemption for Treasuries didn't arouse much opposition until two months ago, after U.S. banks began calling representatives of foreign governments in Washington, warning that sovereign-debt prices would suffer if they weren't allowed to buy the bonds for their trading accounts, say lobbyists and regulators familiar with the talks.

The aim was to augment anti-Volcker-Rule pressure from banks with angry foreign governments. It's working. In yesterday's Financial Times, the respective finance ministers from the U.K. and Japan penned an op-ed, urging:

All countries need to be alert to the unintended consequences of reforms. The "Volcker rule" is a prime example. These proposals aim to reduce risky behaviour within banks. However, there is an exemption for trading in US government securities but not other sovereigns, so it could reduce liquidity in non-US sovereign markets, making it more difficult, costlier and riskier for countries to issue and distribute debt. At such a vulnerable time in the sovereign debt markets, it would be the wrong prescription.

If not now...
If ever there was a time for U.S. lawmakers and regulators to feel like they have the upper hand on big banks, or an opportunity to say, "Go suck an egg, this is the new regulation, so deal with it," it would seem that time is now.

If regulators can't stare down the banks' lobbyists and put the kibosh on the risky activities right after those activities helped bring our financial system to its knees, then what can we expect for the future? Will there ever be any reining in of the financial sector?

MIT economics professor Simon Johnson thinks there may still be a glimmer of hope. He thinks that the banks' lobbying effort will backfire because regulators will feel compelled to not give into foreign governments. "It would look bad before elections to cave in to foreign demands when your public wants you to be tough on banks."

I think the extent to which their efforts have already made the Volcker Rule all but useless is pretty darn scary. But that's just me. Some investors may actually be taking the "if you can't beat 'em, join 'em" tactic, though. As my fellow Fools note in a recent Motley Fool special report, some of the savviest investors have been buying banks. You can check out a free copy of that report by clicking here.

The Motley Fool owns shares of JPMorgan Chase, Citigroup, and Bank of America. Motley Fool newsletter services have recommended buying shares of Goldman Sachs. 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.

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.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 24, 2012, at 10:09 AM, JGDTexas wrote:

    This demonstrates the power of lobbyists, the lack of accountability in Gov't (one more time), the spinelessness of Congress (one more time) and the need to change out enough of Congress with people of principal in iorder to be able to save the Republic. As for savy investors investing in banks, that seems to point to the amount of really short term trading mentality there is and the ability to get in and out of a trade (not an investment) quickly that they feel confident in making big bets on volatile areas. As for mere mortals trying to invest, if you happen to be smart enough to make good decisions on the edges of the real game, then you make out.

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