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Shaun Lal

Professor Sara Keeth


RHET 1302
29 April 2015
Examining the Volcker Rule and Wall Street Culture
Following the 2007-2008 global financial crisis, lawmakers and financial
institutions shuffled to reorganize the financial system. What came about was the 2300page DoddFrank Wall Street Reform and Consumer Protection Act, an encompassing
bill passed on July 21, 2010, designed to reform and regulate the financial services
industry. Although the bills reach spans across numerous areas of the industry, one of
the most significantand controversialsections of the bill is Section 619, which
introduces the Volcker Rule, prohibiting banking entities from engaging in proprietary
trading. The final 271-page Volcker Rule was not completed until January 31, 2014, after
shuffling through the approval of five different regulating agencies, including the Federal
Deposit Insurance Company (FDIC) and the Federal Reserve, which received more than
18,000 public comments over a five-month submission period. Across the financial
sector, the Volcker Rules ban on proprietary trading was debated for its legitimacy as an
issue requiring Dodd-Frank-scale attention. Although proprietary trading cannot be
spotlighted as a sole cause of the financial crisis, the events it led to and hazardous
culture it shaped validate the Volcker Rules prohibition on proprietary trading; however,
that problematic culture cannot and will not be curtailed until it faces proper and tangible
consequences in the form of prosecuting individual traders and executives, not just their
corporations.

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The Volcker Rule Defined
The Volcker Rule, named after former Chairman of the Federal Reserve Paul
Volcker, who served as the chairman for President Obamas Economic Recovery
Advisory Board from 2009-2011, prohibits banks and banking entities from
(1) Owning or investing in hedge funds and private equity funds.
(2) Engaging in proprietary trading.
This paper will focus on the latter prohibition on proprietary trading, which the
final version of the rule defines as engaging as principal for the trading account of the
banking entity in any transaction to purchase or sell, or otherwise acquire or dispose of, a
security, derivative, contract of sale of a commodity for future delivery, or other financial
instrument (Prohibitions). In essence, by banning proprietary trading, the Volcker Rule
prohibits banking entities from buying and selling investments for their own accounts
rather than their clients (Gandel). As stated in the final rule, the term banking entity
refers to any depository institution insured by the FDIC, which includes traditional
commercial banks like Bank of America and JPMorgan Chase, as well as investment
firms that hold federally insured deposits like Merrill Lynch and Goldman Sachs.
Trading financial instruments involves speculating on markets that include an element of
risk; so, the Volcker Rule is intended to prevent banking entities from risking their
depositors money while being insured by the governments FDIC and having access to
emergency funds from the Federal Reserve (Chatterjee). The final rule provided a
generally non-controversial exception for market makingserving as the middleman
between buyers and sellers of financial instrumentsand certain hedging activities,
which banks engage in to reduce the risks of other permitted activities.

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Proprietary Trading and Causes of the 2007 Crisis
Before examining the validity of the Volcker Rule, we must first understand the
role of proprietary trading in the 2007 economic recession. According to a report from
the US Government Accountability Office, in the 13 quarters leading up to the crisis,
proprietary trading accounted for $15.6 billion of revenue for the six largest bank holding
companies, but in the next five quarters, it accounted for $15.8 billion in losses
(Chatterjee, 48). The domino effect of institutional failure in the financial sector began
with the Lehman Brothers bankruptcyprompted by over $32 billion of losses from
proprietary trading (Gandel)shocking investors to question the transparency of their
financial institutions (FCIC). Soon after, Goldman Sachs shifted from an investment firm
to a Bank Holding Company, securing FDIC-backed insurance, after flooding the market
with subprime mortgages and making proprietary bets against them (Goldman Sachs
actions will be investigated further in a later section of this paper.) Finally, capping off
months of financial industry disaster, Merrill Lynch was sold to Bank of America at a
67% markdown from their January 2007 price, after losing short of $20 billion in
proprietary bets (Gasparino). Even after the passage of Dodd-Frank, but before full
implementation of the Volcker Rule (which will not occur until July of 2015), one trader
alone at JPMorgan Chase lost over $6 billion in the now infamous 2012 London Whale
investment scandal.
However, the sole government study reporting the causes of the recession, the
Financial Crisis Inquiry Commission (FCIC), did not find proprietary trading as a major
cause of the crisis. According to an article posted on Harvard Law Schools Forum on

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Corporate Governance and Financial Regulation summarizing the FCIC report, the
Volcker Rule does not address the problems leading to the crisis:
The ultimate causes of the financial crisis included a combination of excessive
origination, purchases and leveraging of low-quality mortgage assets; the impact
of the [over-the-counter] derivatives and securitization markets in accelerating the
transmission of financial distress when the mortgage markets began to fail;
inadequate regulatory oversight of the participants in the home mortgage and
structured finance markets; and a general failure on the part of the financial
markets and their regulators to recognize and address the correlation risks
associated with the dramatic growth in this asset class. (Horn, Smith)
The FCIC found that the financial crisis was not acutely caused by failed proprietary
investments of the largest private financial institutions, but rather systemic failure of
financial regulators, individual borrowers, an influx of virtually unpayable subprime
mortgages, and government-sponsored mortgage providers such as Fannie Mae and
Freddie Mac, which accounted for 44% of the 27 million subprime mortgages on the
market before the crash, assisting in creating a housing bubble that was doomed to pop
(FCIC).
However, proponents of the Volcker Rulenamely, Paul Volcker himself
maintain that although the ability of banks to engage in proprietary trading did not solely
create the financial crisis, it created a culture of the commercial banking institutions
involved, manifested in the huge incentives to take risk inherent in the compensation
practices for the traders (Volcker). To understand this risky culture, we continue the
discussion of Goldman Sachs role in the financial crisis.

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The Problematic Culture Surrounding Proprietary Trading
Along with Fannie Mae and Freddie Mac, Goldman provided low-credit
homeowners with subprime mortgageshigh-risk mortgages offered at low teaser
interest rates that will rise steeply with the prospect that the homeowners income will
increase in the future (Nasdaq). According to Nasdaqs definition of subprime mortgages,
in periods of economic downturn, these mortgages are the first to run into trouble. The
New York Times explains the results of Goldmans subprime lending on the actual
borrowers themselves:
Three-fourths of the borrowers in the [Goldman] deal have fallen well behind on
their payments at some point, according to a special analysis of the deal
performed by the Federal Reserve Bank of Boston. Many of those people have
lost their houses or will lose them. Nearly half the loans in the bond have been in
foreclosure proceedings since it was issued, according to the Boston Fed. (Eavis)
So, where do Goldman Sachs questionable lending practices fit in a discussion of
proprietary trading?
When viewed in a vacuum, Goldmans subprime mortgages seem to further the
point that the failure of regulating agencies to pick up on unmanageable risks was more
responsible for creating the financial crisis than banking entities engaging in proprietary
trading. However, as discovered by the Senate Permanent Subcommittee on
Investigations during its inquiry of the financial crisis, Goldman not only packaged risky
mortgages to subprime borrowers, but then covered its losses from defaults on
subprime mortgages by making proprietary bets that the prices of their own mortgages
would drop (Sloan). So, when the predatory housing bubble did pop, subprime

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homeowners defaulted on their junk mortgages, just as their provider, Goldman Sachs,
made bets that it would. The subcommittees investigation uncovered Goldmans internal
emails, including one Goldman Sachs managers reaction to the downgrading of $32
billion of mortgage related securities: Sounds like we will make some serious money
because, as his colleague replied, we are well positioned in bets that the mortgages will
lose value (Chan, Story).
Although this particular unjust practice was, by public accounts, specific to
Goldman Sachs, risk-taking culture was imbedded in big financial institutions,
incentivizing the practices that led to the crisis. Merrill Lynch, which overall lost $30.48
billion in 2008, paid out $3.6 billion in bonuses in the same year. Additionally, these
bonuses696 of which were for at least $1 million eachcame from $45 billion of loans
granted to Merrill Lynchs new owner, Bank of America, by the governments taxpayerfunded Troubled Assets Relief Program (TARP). Goldman Sachs, itself, paid more than
twice the amount of their 2008 net assets in bonuses that year, rewarding a combined
$45.9 million to just their top four bonus recipients (Cuomo).
And although proprietary trading did not cause banks to lose all of their
depositors moneysuch as in the case of JPMorgan Chase, whose $6 billion London
Whale trading loss and subsequent $920 million fine is undermined by their record profit
that year of $21.3 billion (Hurtado)Volckers broader argument is that as long as big
banks are benefitting from public safety nets such as backing from the FDIC and TARP,
risking both depositor money directly and taxpayer money indirectly through proprietary
trading is unjustified because it is engaged in primarily for the benefit of limited
groups of highly paid employees (Volcker).

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However, if Paul Volcker is serious about curbing Wall Streets greedy culture,
and more importantly, if President Barack Obama truly believes that we cannot return to
business as usual, as he stated in his January 2010 remarks introducing the Volcker
Rule, enforcing prohibitions on proprietary trading will not alone suffice.
Too Big to Jail and Final Conclusions on Wall Street Culture and the
Volcker Rule
In the prosecution following their involvement in the 2008 financial crisis, the six
largest banks were forced to pay nearly a combined $83 billion in fines through lawsuit
settlements; however, 100% of the penalties were absorbed by stockholders, as
settlements ensured that no top executives were forced to pay out of their own pockets, or
even charged for any crimes related to the crisis (Kaufman).
Similarly alarming is the insignificant size of the fines relative to profits.
JPMorgans historic settlement costs of $21.2 billion are dwarfed by their $98.5 billion in
profits from 2009-2014 (Breslow). Disregarding Bank of Americawho agreed to the
largest settlement between a private company and the US government in historynone
of the top six banks reached a settlement deducting more than 22% of profits during the
five year period following the financial crisis. In fact, Goldman Sachs total settlement
cost amounted to less than 2% of profits.
Which begs the question, if no top executive is held personally responsible for
their actions leading to the financial crisis, and punishments for such actions barely
scratch the surface of profits from such actions, is a prohibition on these actions enough
to curb the culture that cultivated incentives to engage in shady practices in the first
place? And additionally, what exactly would constitute bankers to face criminal charges?

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Recent decisions from the Department of Justice indicate that regardless of
whether or not banning proprietary trading would alone suffice to break Wall Streets
problematic cultureand most sign lead towards notthe role, and rule, of banking
executives atop the financial sector is deemed too big to jail (Kaufman). Even in the
2012 DOJ case finding British bank HSBC guilty of money laundering for the Mexican
Sinaloa drug cartel and organizations linked to Al Qaeda and Hezbollah, among other
verified instances of criminal fraud, the $1.9 billion fine only amounts to about five
months of profit, and no individual spent a penny from their own pockets or a day in jail
(Taiibi).
In April of 2010, President Obama delivered a second speech on Wall Street
Reform, in which he evaluated that the crisis was born on a failure of responsibility
from Wall Street all the way to Washington and even condemned the enormous
executive bonuses that created perverse incentives to take reckless risks that
contributed to the crisis, adding that it offends our fundamental values.
But, in August of 2014, a Wall Street Journal headline read U.S. Bank Profits
Near Record Levels while no executive faced legal consequences for their contribution
to a crisis that dispossessed over 1.2 million American households (Schoen).
So, although proprietary trading is not the sole cause of the global financial crisis,
it exacerbated the problem and reinforced the greedy culture rampant across Wall Street,
deeming the Volckers rules ban on proprietary trading valid as one step towards
cleaning up the financial sector. But furthermore, as Volcker and President Obama
correctly assess that the conversation should be focused on the problematic culture of
Wall Street, funds should have been allocated towards a large-scale Department of

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Justice overhaul charging banking executives with fraudulent crimes they committed,
instead of just focusing four years of efforts on a 271-page rule and relatively miniscule
consequences through settlements and fines.
As a suggestion to readers of this paper, further research pertaining to other
countries alternative responses to financial crisis should be explored. In February of
2015, Icelands Supreme Court upheld criminal convictions of four top bank executives
responsible for Icelands own 2008 financial crisis, each receiving sentences between
four and five years in prison (Reuters).
In America, the actions leading to the crisis were criminal enough to warrant
lawsuits against the individual banks, but the individual bankers were the actual culprits
of the crimes, and they effectively dodged the consequences. If any individuals role is
indeed deemed too big to jail, then it is the legal system that needs reform.

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Works Cited
Breslow, Jason M. "How Bank of Americas $16.65 Billion Settlement Compares."
Frontline. PBS, 21 Aug. 2014. Web. 28 Mar. 2015.
Chan, Sewell, and Story, Louise. "Goldman Cited Serious Profit on Mortgages." The
New York Times. N.p., 24 Apr. 2010. Web. 28 Mar. 2015.
Chatterjee, R. R. "Dictionaries Fail: The Volcker Rule's Reliance on Definitions Renders
It Innefective and A New Solution Is Needed To Adequately Regulate Proprietary
Trading." BYU International Law and Management Review 8 (2011): n. pag.
BYU Law, Winter 2011. Web. 28 Mar. 2015.
Chaudhuri, Saabira, and Robin Sidel. "U.S. Bank Profits Near Record Levels." Wall
Street Journal. N.p., 11 Aug. 2014. Web. 29 Apr. 2015.
Conclusions Of The Financial Crisis Inquiry Commission. Rep. Stanford, 27 Jan. 2011.
Web. 8 Apr. 2015.
Cuomo, Andrew. No Rhyme Or Reason: The 'Heads I Win, Tails You Lose' Bank Bonus
Culture. Rep. State of New York Office of Attorney General, 30 July 2009. Web.
28 Mar. 2015.
Eavis, Peter. "In One Bundle of Mortgages, the Subprime Crisis Reverberates."
Dealbook. The New York Times, 12 Aug. 2013. Web. 8 Apr. 2015.
Gandel, Stephen. "Is Proprietary Trading Too Wild for Wall Street?" Time. N.p., 5 Feb.
2010. Web. 8 Apr. 2015.
Gasparino, Charlie. "Bank of America to Buy Merrill Lynch for $50 Billion." CNBC.
N.p., 14 Sept. 2008. Web. 8 Apr. 2015.

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Horn, Charles, and Smith, Dwight. "The Parallel Universe of the Volcker Rule."
Editorial. 29 July 2012: n. pag. Harvard Law School Forum on Corporate
Governance and Financial Regulation. Web. 8 Apr. 2015.
Hurtado, Patricia. "The London Whale." Bloomberg. N.p., 16 Oct. 2013. Web. 8 Apr.
2015.
"Iceland Convicts Bad Bankers and Says Other Nations Can Act." CNBC. Reuters, 12
Feb. 2015. Web. 29 Apr. 2015.
Kaufman, Ted. "Why DOJ Deemed Bank Execs Too Big To Jail." Forbes. N.p., 29 July
2013. Web. 28 Mar. 2015.
Obama, Barack. "Remarks by the President on Financial Reform." The White House
Diplomatic Reception Room, Washington D.C. 21 Jan. 2010. The White House.
Web. 30 Mar. 2015.
Obama, Barack. "Remarks by the President on Wall Street Reform." Cooper Union, New
York. 22 Apr. 2010. The White House. Web. 29 Apr. 2015.
Prohibitions and Restrictions on Proprietary Trading and Certain Interests In, and
Relationships With, Hedge Funds and Private Equity Funds, 79 Federal Register
et seq. (2014). Print.
Schoen, John W. "Study: 1.2 Million Households Lost To Recession." NBC. N.p., 8 Apr.
2010. Web. 29 Apr. 2015.
Sloan, Allan. "Junk Mortgages under the Microscope." Fortune. N.p., 16 Oct. 2007. Web.
8 Apr. 2015.
"Subprime Mortgage Definition." Financial Glossary. Nasdaq, 2011. Web. 9 Apr. 2015.

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Taibbi, Matt. "Gangster Bankers: Too Big To Jail." Rolling Stone. N.p., 14 Feb. 2013.
Web. 6 Apr. 2015.
Volcker, Paul A. "Commentary On The Restrictions On Proprietary Trading By Insured
Depository Institutions." Editorial. Wall Street Journal, 13 Feb. 2012. Web. 8
Apr. 2015.