Wall Street reform died this week.
It died Tuesday before the Senate Banking Committee from unnatural and illogical causes: the finance lobby, obstruction, fear-mongering and plain ignorance.
Rarely does financial history offer a living, breathing voice of reason in crucial times, but listening to Paul Volcker spell out his plan for reform was such an event. Too bad for all of us, his prescription for reform will be discarded like loan underwriting standards for a multi-family home near Las Vegas.
Bloomberg News
Paul Volcker
The former chairman of the Federal Reserve hit the committee like a ghost of banking past -- and future -- leaving the rule that bears his name on the doorstep of Capitol Hill. His plan is not a pure return to the dreaded Glass-Steagall days, but to those in Congress who are lining up to kill the plan, it may just as well have been that and more.
Mr. Volcker's testimony was at once a brilliant articulation of the structural dangers of Wall Street as it stands and a forceful warning. He clarified the most controversial part of the rule, the ban on proprietary trading for commercial banks.
A bank "trading for its own account, it will almost inevitably find itself, consciously or inadvertently, acting at cross purposes to the interests of an unrelated commercial customer of a bank," he said in prepared testimony.
This state of affairs at big institutions such as Bank of America Corp., Citigroup Inc. and J.P. Morgan Chase & Co. is more than just a conflict. It is an all out internal war at the heart of these institutions pitting the money system so important to the economy with the risk-taking system important only to those who benefit from the betting windfall.
But given the reaction of committee members, the Volcker Rule appears to be doomed. By the end of his testimony the dais was nearly empty. Big bank stocks rallied. The only question now is whether the bill will be gutted or euthanized like failed investment banks would have been under the Volcker plan.
Cause and Competition
Richard Shelby, the committee's ranking Republican, apparently has agreed to carry the mantle for Wall Street interests (an assertion he denies). He questioned Mr. Volcker in a fashion that suggested the utmost respect for a great hero of economic crises past and the patronizing condescension one would give an 82-year-old suspected of being out-of-touch with the modern financial world and, perhaps, a bit senile.
. Sen. Shelby asked Mr. Volcker if there was any evidence proprietary trading contributed to the financial crisis and pointed out that Lehman Brothers and Bear Stearns Cos. were not commercial banks. Then he suggested that unilaterally imposing the rule in the U.S. market would handicap U.S. institutions globally.
Mr. Volcker did not have a compelling answer on the first point and seemed to stumble when pressed by Sen. Shelby on how regulators would measure "excessive growth" in bank liabilities. It's like "pornography, you know it when your see it," Mr. Volcker said.
He also conceded that in order to keep U.S. banks competitive, the same restrictions would need to be adopted overseas.
There's more to it than that, of course. When it comes to proprietary trading and the recent financial crisis, big banks did get hit by their trading desks.
In the fourth quarter of 2008 J.P. Morgan reported $1.1 billion in losses due to mortgage-related exposures and weak trading results in credit-related products. A single Merrill Lynch trader lost $120 million on bad currency bets alone contributing to $13.8 billion loss for the firm in its last three months before being acquired by Bank of America Corp. Citigroup Inc. lost $600 million in the third quarter of 2007 on its fixed-income desk.
They are sobering numbers that illustrate why depository institutions shouldn't be taking these kinds of bets. Were they the pure cause of the crisis? No. Did they make matters worse? Undeniably so.
As for U.S. competitiveness, the concern is secondary to preserving our own economic system. But let's play Sen. Shelby's game.
Mr. Volcker said there are 20 or less banks in the world engaging in the kinds of Wall Street businesses his rule targets. Most are concentrated domestically and in the United Kingdom, Switzerland and Germany. We probably can't go it alone, but we only need one or two of those nations to impose similar restrictions.
As Sen. Christopher Dodd put it. If we don't do anything they probably won't. If we do, they are likely to follow.
Evaporating Support
At first, Sen. Dodd seemed to back the Volcker Rule, but in subsequent statements, he's backtracked. Even with his support, it's unlikely to move reform forward. He's not running for reelection this fall. His political persuasiveness has been undercut.
Sen. Shelby has his own interests. He is running for reelection this year. Wall Street has been the leading contributor to his campaign and the leadership political action committee this cycle, with $600,000 in donations through Jan. 10, according to the Center for Responsive Politics. Add the real estate and insurance industries and Mr. Shelby has taken $2 million from financial interests, more than double the contributions from the next leading industry, the CRP said.
Jonathan Graffeo, a spokesman for Sen. Shelby, said the senator was a "leading opponent in the Senate to the taxpayer bailout of Wall Street." He said Wall Street's top priorities in financial regulatory reform is ensuring that its weak regulator, the Federal Reserve, retains regulatory authority and gains the ability as a "systemic risk regulator" to designate them too big to fail. "Ensuring that those things do not happen and ending taxpayer bailouts are Sen. Shelby's top priorities in regulatory reform," Mr. Graffeo said.
While Sen. Shelby "clearly stated at the outset of (the) hearing on the Volcker rule that he was willing to consider the proposal's view", the banking committee "did not receive answers as to why the proposal is necessary given existing statutory authority, or how proprietary trading contributed to the financial crisis, Mr Graffeo said. "If proprietary trading contributed to the crisis and regulators had but did not use authority to restrict it, Sen. Shelby believes we should hold them accountable, not give them more authority."
Sen. Shelby is clear that he doesn't support the amendment for the reasons given. He also doesn't like how the administration "air dropped" the Volcker Rule into the mix when Capitol Hill is already working on the reforms presented by the Treasury Department. Sen. Dodd echoed this adding that the rule was "excessively ambitious" to the point that it could stall all reform.
Complaining about the timing is rich coming from a do-nothing legislature that has failed to move on those reforms more than 16 months after the failure of Lehman Brothers. Moreover, ambition – to create a response equal to the crisis we've endured – isn't stalling reform. It is real reform.
But that's how it is in Washington these days. Unlike the Congress of the 1930s this body is more beholden to politics than to reforming a broken system that has put the American economy in a hole so deep the competitiveness of every American industry is now in question.
History be damned, they told Mr. Volcker. Even if we're doomed to repeat it.
Write to David Weidner at david.weidner@dowjones.com
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