The Wild, Off the Mark Arguments Against the Volcker Rule

Big banks are formulating a host of arguments —wild, off the mark arguments — aimed at dismantling the Volcker Rule firewall between loan-making, customer-serving banks and high-risk hedge funds.

That firewall is essential for a stable banking system. When hedge funds blow up, and they regularly do, one doesn’t want them taking out our loan-making system that is so vital to our families and businesses.

MF Global, for example, blew up just a few months ago due to big bets on currency markets. But those bad bets didn’t damage our banking system, because MF Global wasn’t part of a bank.

So why do big banks want to tear down the Volcker firewall? Quite simply, hedge funds and similar trading buried in legitimate risk hedging and market-making are big business and, often, make big profits. Moreover, hedge funds inside banks have a competitive advantage by benefiting from government subsidies in the form of insured deposits and access to the Federal Reserve discount window.

So what are the arguments the banks are making to attack the Volcker firewall? First they argue that the Volcker firewall will hurt retired teachers and cops by decreasing “liquidity” in markets, which is how easy or hard it is to buy or sell securities. They argue that any decrease in bank trading will make it harder for investors to buy or sell stocks and bonds, which they assert will increase the amount that investors will have to pay for transactions, thereby decreasing the profits for pension funds of retired teachers and cops.

Wrong. First, the Volcker rule explicitly allows for “market-making” by bank brokers. Banks will continue to be able to serve investors by helping them make trades. Second, if additional trading is truly profitable without the support of the discount window and FDIC-insured deposits, such trading will take place outside of banks as it has for decades. Third, “liquidity” is not a holy grail. Being able to trade ever faster is not always an economic gain, either for investors or for the economy. High speed trading and computerized trading don’t add much to the economy, and they can do massive damage when things go awry.

For these and other reasons, pension funds such as CalPERS, the nation’s biggest, support the Volcker Rule because they depend on a stable financial system free from boom and bust cycles. Moreover, they benefit by reducing the conflicts of interest that derives from massive hedge fund trading by multi-trillion dollar banking institutions.

A second major line of attack that the banks have opened up on the Volcker firewall is it will raise gas prices even further. They even have a fancy study for their conclusion, financed by Morgan Stanley, where they argue that if a bank cannot make massive bets on the price of oil, then the price of gasoline will go up and 180,000 jobs will be lost.

Wrong. The evidence points in the opposite direction. When big banks invest huge sums on the belief that oil markets are going up, it creates an artificial surge in demand that raises the price of oil. A recent Goldman Sachs report estimated that oil speculation increases the price of gasoline by about 56 cents per gallon. Even the chairman of Exxon-Mobil estimated that the true price of a barrel of oil based on supply and demand should be in the $60-70 range at the same time prices were over $100.

A strong Volcker firewall, by getting the banks out of the commodities trading market, will reduce excessive speculation, creating a pathway to more stable prices.

As Chairman Volcker has emphasized, U.S. markets worked well for 60 years under a much tougher Glass-Steagall separation of commercial banking from investment banking, including strong limits on bank participation in commodities. Similarly, the markets will work very well under the Volcker Rule’s modernized firewall.

The big banks aren’t paying for phony studies, and shielding themselves behind teachers, cops, and drivers because they want to actually lower prices for anyone.Rather, they are doing it because the Volcker firewall will force them to give up the hedge fund-like trading that makes them billions of dollars in profits in good times, but billions of dollars in losses when things go south.

When hedge fund trading blows up the banks, it will deeply damage loan-making for families and business across America, causing deep economic destruction. In short, and to paraphrase Warren Buffet’s comments, hedge funds inside banks are instruments of mass financial destruction.

The sooner the Volcker firewall is implemented, the better for all of us.