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Efficient Market Proponent Senator Kaufman Endorses Prop Trading Ban, 99 Other Senators Have No Idea What Prop Trading Is

Tyler Durden's picture




 

Mr. President, I rise today in support of President Obama’s proposal to limit the proprietary trading activity of banks, ideas that have been developed by Paul Volcker, the former Federal Reserve Chairman and current chairman of President Obama’s Economic Recovery Advisory Board.

Mr. President, it has been well over a year now since the bursting of a massive speculative bubble, fueled by Wall Street greed and excess, brought our entire financial system to the brink of disaster. 

The resulting economic crisis, the worst since the Great Depression, has had profound effects on regular, working-class Americans in the form of millions of job losses and home foreclosures, to say nothing of the hundreds of billions of taxpayer dollars used to prop up failing institutions deemed “too big to fail.”

In the coming weeks, the Senate will begin consideration of landmark financial regulatory reform legislation.

As it does, we owe it to the American people to ensure that never again will the risky behavior of some Wall Street firms pose a mortal threat to our entire financial system.  The rest of us simply cannot afford to pay for the mistakes of the financial elite yet another time.   

As we look to build a better, more durable, more responsible financial system, we must reflect on the fateful decisions and mistakes made over the past decade that led us to this point. 

We can begin with Congress’ repeal of the Glass-Steagall Act.  Glass-Steagall was adopted during the Great Depression primarily to build a firewall between commercial and investment banking activities. 

But the passage of the Gramm-Leach Bliley Act of 1999 tore down that wall, paving the way for a brave new world of financial conglomerates. 

These institutions sought to bring traditional banking activities together with securities and insurance businesses, all under the roof of a single “financial supermarket.”

This was the end of an era of responsible regulation.  It was the beginning of an emerging laissez-faire consensus in Washington and on Wall Street that markets could do no wrong. 

Not surprisingly, this zeitgeist of “market fundamentalism” pervaded regulatory decisions and inaction over the past decade. 

It allowed derivatives markets to remain unregulated, even after the Federal Reserve had to orchestrate a multi-billion dollar bailout of the hedge fund Long Term Capital Management, which had used these contracts to leverage a relatively small amount of capital into trillions of dollars of exposure. 

It also provided a justification for the Federal Reserve and other banking regulators to ignore widespread instances of predatory lending and deteriorating mortgage origination standards. 

It prompted regulators to rely upon credit ratings and banks’ own internal models, instead of their own audits and judgments, when determining how much capital banks needed to hold based upon the riskiness of their assets. 

Perhaps most importantly, this era of lax regulation allowed a small cadre of Wall Street firms to grow completely unchecked, without any regard to their size or the risks they took.  

In 2004, the Securities and Exchange Commission established a putative regulatory oversight structure of the major broker-dealers, including Goldman Sachs, Morgan Stanley, Lehman Brothers, Merrill Lynch and Bear Stearns, that ultimately allowed these firms to leverage themselves more than 30 times to 1. 

Emboldened by the careless neglect of their regulator, these Wall Street institutions constructed an unsustainable model punctuated by increasingly risky behavior. 

For example, some firms used trillions of dollars of short-term liabilities to finance illiquid inventories of securities, engage in speculative trading activities and provide loans to hedge funds. 

When their toxic assets and investments went south, these highly-leveraged institutions could no longer roll over their short-term loans, leading them – and all of us – down a vicious spiral that required a massive government bailout to stop. 

Despite this extremely painful experience, Wall Street has resumed business as usual.  Only now, the business is even more lucrative. 

The financial crisis has led to the consolidation of Wall Street. 

The survivors face less competition than ever before, allowing them to charge customers higher fees on transactions, from equities to bonds to derivatives. 

In addition, in the wake of the financial crisis, markets remain volatile and choppy.  Firms willing and able to step into the breach have generated higher returns. 

Mr. President, until this Congress acts, there is no guarantee that the short-term trading profits being reaped by Wall Street today won’t become losses born by the rest of America down the road. 

Mr. President, as many of my colleagues know, I have come to the floor repeatedly to warn about the short-term mindset on Wall Street, embodied by the explosive growth in high frequency trading. 

In just a few short years, high frequency trading has grown from 30 percent of the daily trading volume in stocks to as high as 70 percent.  It has been reported that some high-frequency firms and quantitative-strategy hedge funds have business relationships with major banks, allowing them to use their services, credit lines, and market access to execute high-frequency trading strategies. 

Under some of these arrangements, these Wall Street banks are reportedly splitting the profits.

In other cases, the major banks have built their own internal proprietary trading desks. 
These divisions often use their own capital to “internalize,” or trade against, customer order flow. 

Such a practice poses inherent conflicts of interest: brokers are bound by an obligation to seek the best prices for their clients’ orders, but, in trading against those orders, firms also have a potential profit-motive to disadvantage their clients.  Both of these arrangements are evidence of a greater problem:  Wall Street has become heavily centered on leverage and trading. 

Undoubtedly, short-term strategies have paid off for banks.  In fact, much of the profits earned by our nation’s largest financial institutions have been posted by their trading divisions. 

But an emphasis on short-term trading is cause for concern, particularly if traders are taking leveraged positions in order to maximize their short-term earning potential.  By doing so, such high frequency strategies, which execute thousands of trades a second, could pose a systemic risk to the overall marketplace. 

In short, Wall Street once again has become fixated on short-term trading profits and has lost sight of its highest and best purposes:  to serve the interests of long-term investors and to lend and raise capital for companies – large and small – so they can innovate, grow and create jobs. 

As I’ve spoken about on the Senate floor previously, the downward decline in Initial Public Offerings for small companies over the past 15 years has hurt our economy and its ability to create jobs.

While calculated risk-taking is a fundamental part of finance, markets only work when investors not only benefit from their returns, but also bear the risk and the cost of failure.  What is most troubling about our situation today is that on Wall Street, it is a game of heads I win, tails you bail me out. 

The size, scope, complexity and interconnectedness of many financial institutions have made them “too big to fail.” 

Moreover, the popularity of the “financial supermarket” model further raises the risk that insured deposits of banks can be used to finance speculative proprietary trading operations. 

Unfortunately, these risks have only been heightened by recent decisions by the Federal Reserve: the first to grant Bank Holding Company charters to Goldman Sachs and Morgan Stanley; the second to grant temporary exemptions to prudential regulations that limit loans banks can make to their securities affiliates.   

There are a number of ways we can address these problems. 

The major financial reform proposals being considered in Congress propose some entity for identifying systemically risky firms and subjecting them to heightened regulation and prudential standards, including leverage requirements. 

In addition, these proposals also include an orderly mechanism for the prompt corrective action and dissolution of troubled financial institutions of systemic importance that is typically based upon the one already in place for banks. 

Although both of these ideas are vital reforms, they are not sufficient ones.  Instead, we must go further, heeding some of the sage advice – as President Obama has today – provided by Paul Volcker. 

Chairman Volcker has said: “[Commercial banking] institutions should not engage in highly risky entrepreneurial activity.  That’s not their job because it brings into question the stability of the institution…It may encourage pursuit of a profit in the short run.  But it is not consistent with the stability that those institutions should be about.  It’s not consistent at all with avoiding conflicts of interest.”

I strongly support the ideas Chairman Volcker has recently put forward regarding the need to limit the proprietary trading activities of banks. 

Indeed, they get at the root cause of the financial meltdown by ensuring Wall Street’s recklessness never again cripples our economy. 

We can reduce the moral hazard present in a model that allows banking to mix with securities activities by prohibiting banks from providing their securities affiliates with any loans or other forms of assistance. 

While commercial banks should be protected by the government in the form of deposit insurance and emergency lending, Chairman Volcker states: “That protection, to the extent practical, should not be extended to broadly cover risky capital market activities removed from the core commercial banking functions.”

Such a reform would completely eliminate the possibility of banks even indirectly using the insured deposits of their customers to finance the speculative trading operations of their securities affiliates. 

In addition, we can bar commercial banks from owning or sponsoring “hedge funds, private equity funds, and purely proprietary trading in securities, derivatives or commodity markets.” 

As Vice President Biden aptly and succinctly put it: “Be a bank or be a hedge fund.  But don’t be a bank hedge fund.” 

Mr. President, that is why I am pleased to be a co-sponsor of the bill introduced by Senators Cantwell and McCain to reinstate Glass-Steagall, because I thought it was a start to this very important conversation.

Separating commercial banking from merchant banking and proprietary trading operations is an important step toward addressing banks that are “too big to fail.” 

Additionally, we need to impose restrictions on size and leverage, particularly on the reliance on short-term liabilities, and give regulators additional powers to break apart firms that pose serious threats to the stability of the financial system or others. 

Reducing the size and scope of individual entities will limit risky banking behavior, minimize the possibility of one institution’s failure causing industry-wide panic and decrease the need to again rescue large failing institutions. 

Together, all of these reforms will create a financial system that is “too safe to fail.”

Mr. President, we cannot continue to leave the taxpayers vulnerable to future bailouts simply because some large banking institutions wish to pursue short-term trading profits. 

For that reason, as Congress works to pass financial regulatory reform in the coming weeks, reducing systemic risk by eliminating conflicts of interest and addressing banks deemed “too big to fail” should be some of our top priorities. 

Separating core banking franchise from speculative activities, imposing tighter leverage requirements and examining the complicated relationships between high frequency traders and banks constitute critical steps toward ensuring our financial markets are strong and stable. 

By adopting these common-sense proposals, we can go a long way toward stabilizing our economy, restoring confidence in our markets and protecting the American people from a future bailout. 

America cannot afford another financial meltdown and the American people are looking to Congress to ensure that that does not happen.

 

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Thu, 01/21/2010 - 15:08 | 200996 wang
wang's picture

please read the fine print

 

The White House background briefing is that their proposals would freeze biggest bank size “as is” — this makes no sense at all.

http://baselinescenario.com/2010/01/21/as-is/

Thu, 01/21/2010 - 15:10 | 201001 CB
CB's picture

congress:  stupid is stupid does

Thu, 01/21/2010 - 16:30 | 201143 Mark Beck
Mark Beck's picture

Exactly.

The congressmen are not uninformed. They have access to the information in understanding the issues before them if they choose to read it. If an item is not covered adequately, they can call the CRS and have a staffer come over with the most up to date information. They are as stupid as they choose to be.

Mark Beck

Thu, 01/21/2010 - 15:20 | 201015 Mr Lennon Hendrix
Mr Lennon Hendrix's picture

It is true.  Politicians know economics as well as they know their constituents. 

Write to your Senators...or send this post. 

Thu, 01/21/2010 - 15:20 | 201017 Anonymous
Anonymous's picture

Warren Buffett out with more self-serving blather:

Geithner is "terrific".

"Bernanke's critics should get down on their knees to thank him."

Warren knows what it's like down on his knees in front of Bernanke and Geithner ... of course, instead of their diseased splooge he got billions from the illegal bailouts.

Enough with Saint Warren.

Thu, 01/21/2010 - 15:24 | 201024 Anonymous
Anonymous's picture

No Sen. Kaufman, we do not look to congress for any relief. The congressional track record speaks for itself. Simply get out of the way, let the chips fall where they may and let the market crucify the rat bastards.

Thu, 01/21/2010 - 15:26 | 201028 lsbumblebee
lsbumblebee's picture

Senator Byrd of Virginia says "thank you" but he already has a pair of poop training pants.

Thu, 01/21/2010 - 16:54 | 201182 Problem Is
Problem Is's picture

"Senator Byrd of Virginia says "thank you" but he already has a pair of poop training pants."

That is CLASSIC isbumblebee...  It gives the job description of the vaunted Senatorial Aide a je ne sais quoi... rest home feel doesn't it??

"Wait, Senator Byrd, hun... let me get up that drool before we wheel you out..."

A more corrupt, useless collection of  senile old white men cannot be found anywhere on planet earth.

Thu, 01/21/2010 - 17:04 | 201194 lsbumblebee
lsbumblebee's picture

Third in the line of presidential succession too!

Be proud America.

Thu, 01/21/2010 - 15:34 | 201040 Anonymous
Anonymous's picture

Wait...

Barney Frank just said no to Obama- game is still on for 3-5 years. Run it up till 2014 and run like hell guys. Morons

Thu, 01/21/2010 - 15:41 | 201061 chindit13
chindit13's picture

Looks like Barney Frank was paid with a post-dated check and thus must keep doing his owners' bidding. Five years to implement? What about initiating new positions now? So TBTF also lasts five more years? Doesn't this "scheduled end" just encourage more reckless behavior, especially as the real end comes near? Next Congressman to feel the wrath of the Massachusetts voter: Barney.

Thu, 01/21/2010 - 15:50 | 201073 Anonymous
Anonymous's picture

Barney Frank wants the phase in stage to last till a republican is in office i guess. No one seems to notice that 40,000 more people than expected were out of work on the job report proving that no one really cares as long as their money isnt affected.
That's how all these problems were caused.
The philosophy of doing the greatest good for the greatest number of people, and that number is ONE.

Thu, 01/21/2010 - 16:06 | 201097 Anonymous
Anonymous's picture

Barney Frank, the human sperm receptacle for all of Wall Street...

Thu, 01/21/2010 - 16:08 | 201103 Anonymous
Anonymous's picture

There is no reason to mandate 5 years....

These operations can be sold....or just separated by legal ease....and operate on their own....

5 years for WHAT ????

Thu, 01/21/2010 - 16:16 | 201114 dabullify
dabullify's picture

Barney Frank, human sperm receptacle for all of Wall St.

Thu, 01/21/2010 - 16:59 | 201188 Problem Is
Problem Is's picture

I thought Cramer the Clown was the human sperm receptacle for all of Wall St.?

Thu, 01/21/2010 - 17:18 | 201212 Mr Lennon Hendrix
Mr Lennon Hendrix's picture

They all are!  Walled St gets off on the hour and needs many receptacles.

Thu, 01/21/2010 - 16:46 | 201175 Anonymous
Anonymous's picture

Rational Expectations Hypoth saved me millions. 25 years ago the bearded professor calmly stated, effectively, that you cant make profits investing in real estate or stock. We were stunned..But Professorhow could this be?... well I never invested in stock or real estate. Saved me millions in losses. AIG , Goldman, CITI, Lehman, Bear, FedReserve should have taked this class with us. I guess those harvard guys were too busy getting drunk and stoned. If I were them, I would ask for my money back.

Fri, 01/22/2010 - 15:43 | 202672 Mr Shush
Mr Shush's picture

Um, seriously?

Of course you can make profits investing in real estate or stock. Do you mean something weaker, like "you can only make profits investing in real estate or stock through alpha"? Because that's still not true - plainly, for example, it's possible to have long term secular increases in demand for real estate, whether due to immigration, a decrease in the co-habitation rate or whatever, and such increases will tend to increase property values. Or suppose you bought the mobile phone sector in the mid-late 90s - I'm guessing you'd have done pretty well overall. Given that your hypothesis seems prima facie implausible, I think it will take more to convince most here than an anecdotal statement to the effect that over an unspecified period a muzzily defined range of investments that you didn't make because of something your professor said lost money, and you therefore did not.

Thu, 01/21/2010 - 17:17 | 201211 Anonymous
Anonymous's picture

Let's not forgot the crap regulation which allowed commercial banks to lend more money than they had to people who couldn't pay it back guys!

Thu, 01/21/2010 - 18:05 | 201295 Anonymous
Anonymous's picture

Lock the cage after the chicken is gone..

Thu, 01/21/2010 - 19:00 | 201374 Anonymous
Anonymous's picture

A Democratic President signed off on both Gramm and CFMA. Many of the present day lifer pols voted for it too. Dunno, but bet Kaufmann's predecessor.....now VP....signed off on both of them .

Nobody wants to get stuck to the unwinding of these two tar babies......afraid it will stick to them with November coming fast. Best insurance for reform is to get rid of all of them.

Hang em all and then you're 100 % sure to get the guilty. And the innocent probably ain't worth a shit, either.

Fri, 01/22/2010 - 04:06 | 201996 Anonymous
Anonymous's picture

OBAMA the RED ...............Thanks , you are just about

to guarantee your loss of office next election carry on

the BS work amigo!!! For Gods sake you dont solve the problem by going from one extreme to another.

The real reason behind the recession is..... POOR PEOPLE wanted to POSSESS BETTER houses , cars and possesions than they could actually afford and they were serviced by even bigger idiots who thought it could work!!

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