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Volcker Rule To Scrap "Portfolio Hedging", Would Make Trillions In Excess Deposits Inert

Tyler Durden's picture


As we have been covering for the past year and a half, most explicitly in "A Record $2 Trillion In Deposits Over Loans - The Fed's Indirect Market Propping Pathway Exposed", when it comes to the pathway of the Fed's excess deposits propping up risk levels, it has nothing to do with reserves sitting on bank balance sheets as assets, and everything to do with excess deposits (of which there are now $2.4 trillion thanks to the Fed) which are used as Initial collateral by banks such as JPM and then funding such derivatives as IG9 in a failed attempt to cover a segment of the corporate bond market. These deposits originate at the Fed as a liability at the commercial banking sector to the excess reserve asset.

That much is clear and undisputed, and was admitted by none other than JPM itself.

Of course, before it was penalized hundreds of millions for Jamie Dimon's tempest in a teapot comments, and implicitly lying before Congress, the party line is that when JPM's CIO unit proceeded to use the $423 billion (at the time) deposit to loan gap as funds to sell IG9 protection, it was "hedging."

It wasn't, and instead it was merely putting on one of the largest prop trades in history which can be confirmed by the great bonus expectations of Bruno Iksil and pals. And since nobody expects to make an extra bonus on a hedge to an existing trade, but always on a new directional trade, one can ignore the lies that any such purely prop trades are covered up with.

Which is why the news overnight from the WSJ that the Volcker Rule (if and when it is implemented) will do away with such "portfolio hedging" trades may have truly major, and potentially very risk adverse, consequences.

The WSJ reports:

In a defeat for Wall Street, the "Volcker rule" won't allow banks to enter trades designed to protect against losses held in a broad portfolio of assets, according to people familiar with the rule.  The practice, known as portfolio hedging, has become a focal point of regulators drafting the rule, a controversial plank of the 2010 Dodd-Frank financial law that seeks to prevent banks from putting their own capital at risk in pursuit of trading profits.


But it won't contain language permitting portfolio hedging, which has been "expunged" from earlier drafts of the rule, according to a person familiar with the matter. Regulators decided to remove portfolio hedging from the rule after J.P. Morgan Chase disclosed billions of dollars in losses from its so-called London whale trades in 2012.


The bank initially described the trades as a portfolio hedge. Now, it is likely other Wall Street firms also will end up paying for J.P. Morgan's slip-up. Regulators, in response to the J.P. Morgan disclosure, pushed to write a rule that would ensure banks couldn't engage in such trades.


The move will come as a blow to banks, which lobbied regulators to keep language allowing portfolio hedging in the rule. Banks often hedge to offset the risks that accompany trading with clients. Sometimes, though, there is no perfect counterweight to those clients' trades. Banks look to portfolio hedging to manage a broader array of risks.


What hedges don't do, regulators wrote, is "give rise…to any significant new or additional risk that is not itself hedged contemporaneously." The excerpt reviewed by the Journal didn't mention portfolio hedging.

For once regulators and politicians not only understood the underlying issues but did the right thing:

Critics said that opened the door for banks to make all manner of bets on the market because a bank might define the risk to its portfolio broadly, such as the risk of a U.S. recession.

And while we are confident the banks will find a way to delay the implementation or outright bring the "hedging" permissive language back, this change - unless remedied - has the potential to make a huge dent on bank P&Ls as it would mean the end of using the Fed's excess reserves to buy up risk and to push the market higher through such instruments as buying ES, selling index protection and other marginable futures and derivatives.

In effect, should the "portfolio hedging" language be kept off the books, it would mean the permanent clogging of a pathway that allowed the Fed's trillions in excess deposits to be used to push stocks higher.

We hardly need to explain the dramatic implications for stocks such a shift would create.


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Thu, 12/05/2013 - 09:27 | Link to Comment slotmouth
slotmouth's picture

The rule is not in effect expect some aggressive "hedging" in the meantime.

Thu, 12/05/2013 - 09:37 | Link to Comment Rainman
Rainman's picture

Implementation date is 7/21/14 .....if the banks can't scuttle it they will then delay it again and again and again . We've all seen this movie before. Bottom line : To fix this mess, you must blow it all up immediately .

Thu, 12/05/2013 - 09:43 | Link to Comment LawsofPhysics
LawsofPhysics's picture

Exactly - "Give me control of a nation's money and I care not who makes the laws."
- Mayer Amschel Rothschild

You blow it all up or end lobbying, good luck with the later...

Thu, 12/05/2013 - 09:48 | Link to Comment Stackers
Stackers's picture

I see the London morning smash down of gold is back on precisely at 8:30 EST again.

Thu, 12/05/2013 - 09:52 | Link to Comment LawsofPhysics
LawsofPhysics's picture

A simple "thank you" will do...

Thu, 12/05/2013 - 10:01 | Link to Comment SafelyGraze
SafelyGraze's picture

the mystery of banking

it is the

- interest on excess reserves at the fed
- return on derivatives collateralized by excess reserves at the fed
- return on derivatives collateralized by excess deposits at the banks

that serves as the primary transmission mechanism to

- inject
- bleed

money into/from the economy, thereby guaranteeing

- stability
- catastrophe 

Thu, 12/05/2013 - 10:31 | Link to Comment falak pema
falak pema's picture

when Scylla and Charybdis bet on who will catch Ulysses's boat...poor sucker, tied to his mast by Circe's Sirens singing : woody, woody, woody, I love ya woody! Give me a high five!  

No day to have a woody being pecked by a Siren hooked on derivative fiat snow powder from FED poppy field !  

Unless you be Woody Allen. "I thought I would learn everything I wanted to know about "knock on wood" but never dared to ask!"

When you knock you open the Pandora's box of derivative squawks. "Here goes a CDS call, there an interest arb short, yonder a Forex put. Groovy, more gravy for the Sirens." 

All orchestrated with chief Siren Ben, Yelling "Com on Yellen its now your turn to peck! "

Poor Greek, its all yiddish to him!

Thu, 12/05/2013 - 10:03 | Link to Comment NoDebt
NoDebt's picture

Steve Liesman said that excess reserves were already inert.  They just sit there- banks aren't allowed to use them for collateral to play in the market.  Remember that one?

This one's for you, Steve.  You tool.

Thu, 12/05/2013 - 10:43 | Link to Comment Lordflin
Lordflin's picture

Well, at least it comes at a seemly hour for you... I have to wake up at 5 in the morning (PST) to see if the fix is in...

Thu, 12/05/2013 - 09:46 | Link to Comment GolfHatesMe
GolfHatesMe's picture

What if we have other Cans to kick on 7/21/14? 

Thu, 12/05/2013 - 09:57 | Link to Comment LawsofPhysics
LawsofPhysics's picture

Now that finance and the monetary system is completely dettached from reality, there are no more cans to kick.  Just look at how california went from a 40+ billion dollar shortfall to a "miraculous recovery", even with several cities on the brink and going bankrupt.

The ivy league cunts will push these strings until the supply lines break in earnest, hedge accordingly.

Thu, 12/05/2013 - 13:19 | Link to Comment Steaming_Wookie_Doo
Steaming_Wookie_Doo's picture

So, are you thinking "terrorist attack" or "start foreign war" by 7/20/14?

Thu, 12/05/2013 - 09:33 | Link to Comment LawsofPhysics
LawsofPhysics's picture

"Rule" -  LMFAO!!!

When fraud is the status quo (as it is now), possession is the law.

Please, in the current "market" there are no "rules" or "laws".

Just ask John Corzine.

Thu, 12/05/2013 - 14:39 | Link to Comment mkkby
mkkby's picture

Exactly!  This "rule" if EVER ENFORCED will only be applied to small banks that goldman wants to buy at a bargain price.  The only rule that will ever get wall street off the people's neck is the rule of rope and lamp posts.

Thu, 12/05/2013 - 09:34 | Link to Comment Cognitive Dissonance
Cognitive Dissonance's picture

It ain't over till the fat (central) banker sings.

Thu, 12/05/2013 - 09:55 | Link to Comment The Duke of Skiatook
The Duke of Skiatook's picture

It ain't over till the fat (central) bankster squeals.

Thu, 12/05/2013 - 09:59 | Link to Comment NoDebt
NoDebt's picture

There's going to be plenty of squealing between now and next July.

Thu, 12/05/2013 - 09:40 | Link to Comment Tinky
Tinky's picture

Now now, readers, wait until the Honorable and – need I add? – independent minded Chuck Schumer presents his carefully thought-out perspective, before deciding on the most prudent course of action.

Thu, 12/05/2013 - 09:43 | Link to Comment Winston Churchill
Winston Churchill's picture

Maxine Walters will be the arbiter.

Thu, 12/05/2013 - 09:43 | Link to Comment Seasmoke
Seasmoke's picture

Why lend money, when you can gamble it. 

Thu, 12/05/2013 - 09:45 | Link to Comment buzzsaw99
buzzsaw99's picture

let it burn

Thu, 12/05/2013 - 09:56 | Link to Comment Miss Expectations
Miss Expectations's picture

Jamie, Jamie, Jamie...did you have to say hedging?

Thu, 12/05/2013 - 09:58 | Link to Comment NoDebt
NoDebt's picture

So THAT'S why the market was down the last 4 days.

Thu, 12/05/2013 - 10:00 | Link to Comment observer007
observer007's picture

BTC over 1000 again


Recovery is under way

Result: Vola-explosen


BTC Realtime qutoes &charts:

Thu, 12/05/2013 - 10:01 | Link to Comment q99x2
q99x2's picture

We are going to live until 7/21/2014. Hopeful you are.

Thu, 12/05/2013 - 10:01 | Link to Comment Quinvarius
Quinvarius's picture

They will just officially abandon banking and announce they are hedgefunds.

Thu, 12/05/2013 - 10:02 | Link to Comment Vin
Vin's picture

Is there mention of legitimate hedging in the rule?  Without that we'll end up with banks having large risk exposures which will inevitably go bad.  Then the banks will come back to the govt and say, 'you wouldn't let us hedge, so bail us out again'.

Thu, 12/05/2013 - 10:31 | Link to Comment razorthin
razorthin's picture

And we'll just say no.  Never let a dug grave go unused.

It will be up to you, me and alternative media to remind the populace that the suffering of the past 6 years was because we acquiesced to Paulson's bullshit. Denying a bailout WON'T equate to the end of civilization.  Life will go on, yes, after intense pain, but much, much sooner.

Thu, 12/05/2013 - 10:18 | Link to Comment RSloane
RSloane's picture

Pretty much, yes. The closed feedback loop of 'government to banks to government' will consist of proven constricture of the banks' ability to function to its full capacity and the expectation that government will remove the constricting laws to prevent a 'crisis'. The threat of crisis always works.

Thu, 12/05/2013 - 10:06 | Link to Comment ejmoosa
ejmoosa's picture

Today's banking system is a farce. Until the ultimate collapse, it's like watching stuck in quicksand trying to rewrite the laws of fluid dynamics and gravity.

Thu, 12/05/2013 - 10:10 | Link to Comment razorthin
razorthin's picture

Inert-tia, bichez.  Volcker comes to the rescue again, wringing out excess.  If we must suffer these bombastic central bankers, we need more like Volcker.

Thu, 12/05/2013 - 10:11 | Link to Comment Last of the Mid...
Last of the Middle Class's picture

It ain't over till the fat (central) bankers sizzle like bacon!

Thu, 12/05/2013 - 10:13 | Link to Comment ToNYC
ToNYC's picture

Tax their 2 Trillion excess and pay-back the ZIRP'd savers is fair play. Too Big to Pay might get them back looking for  Alice's magic pill from Dr. Fed to get them right-sized to their deposit base.

Thu, 12/05/2013 - 10:14 | Link to Comment YHC-FTSE
YHC-FTSE's picture

Chances of implementation: almost zero. None of these junkies addicted to the game of  chancing on the most obscure and risky  financials with deposits are going cold turkey. None of these CIOs are going to like forgoing the chance to make (or lose) big bonuses and the cash flow the banks desperately need to prop up their bankrupt business model. 

If they can't hedge on their portfolio with clients' funds, they'll get it somewhere else, change the lingo, or change the rules. What else are they going to do?  Fire their entire prop trade desk? Make a few bucks charging management fees, and live on noodles?  Come on! The moment this rule is implemented, they're likely to carry on expecting to pay less than 10% of their profits in fines as the cost of doing business.  If they ever even go to court. That's not cynicism, but reality and observations. 

Thu, 12/05/2013 - 10:21 | Link to Comment RSloane
RSloane's picture

Exactly. Either 'threat of crisis' or change in language describing the activity is going to happen. Prudence in banking is not even on the horizon line.

Thu, 12/05/2013 - 10:25 | Link to Comment Amagnonx
Amagnonx's picture

Let me try and understand this, if this rule comes into effect it will mean excess reserves lodged at the FED will not longer be able to be leveraged into stock market inflation.


This means that unless the FED increases the interest rates on the reserves, that the banks will have to lend them out.  If the FED increases interest rates it would probably start to make the FED run at a loss, which might be a little bit too in your face theft, so lets say they dont do that.

So the banks will then have all these reserves that they will need to lend?  So inflation in everything?

Thu, 12/05/2013 - 10:54 | Link to Comment Squids_In
Squids_In's picture

99% of the market doesn't know why or how QE levitates the stock market - all they know is: "It just does" and "This time it's different". Thus, the Fed has created a major problem to manage expectations. The market is based on pure superstition and has developed an obsessive focus on Fedspeak. Bernacke can't very well start telling the truth about bankrolling Wall Street's gambling habit or the negative implications of the Volker rule, without upsetting the apple-cart  But TBTF Prop desks will have to start a wind down of positions well before the July deadline. If I was sitting on the investment committee - I'd say start the get-out now. If everybody has the same position, then it is a classic prisoners dilemma trade: first one to cheat, wins. And remember, they still have a chance to sell to the punters before Yellen even whispers the magic word: "taper." 

Thu, 12/05/2013 - 10:55 | Link to Comment ThisIsBob
ThisIsBob's picture

Meanwhile the Washington Post reports that 1/3 of all bank tellers rely on public assistance.  Walbankmarts.

Thu, 12/05/2013 - 10:59 | Link to Comment vote_libertaria...
vote_libertarian_party's picture

My guess is the banks will still do it, but rebranded.


Gvt:  You can longer hedge or trade on your account


Banks: Ok, we don't do that. We 'self direct invest'.



There....fixed it!

Thu, 12/05/2013 - 12:35 | Link to Comment kaiserhoff
kaiserhoff's picture

Right you are, sir.

Been there, done her.

This is not our first rodeo.

Thu, 12/05/2013 - 11:12 | Link to Comment Squids_In
Squids_In's picture

@Amagnonx Banks can only lend excess reserves to other banks or to the Fed, so this form of money is "trapped" inside the banking system. But - stroke of genius - excess reserves can be pledged as collateral on derivative trades without leaving the banking system. If banks no longer need collateral then I guess these reserves just sit there until the Fed runs down it's balance sheet. The babks do earn 25pips on them sand they carry a zero capital weight - so don't shed a tear.

Thu, 12/05/2013 - 11:49 | Link to Comment Amagnonx
Amagnonx's picture

Cool - thanks for that, I think I kind of got the idea.  Basically means deadweight in the bank inventory, excepting whatever interest the FED pays out(?).  I heard someone floating an idea about charging customers for deposits - I guess that would be in an effort to lighten the excess reserves and get people spending (all that money!).


Hah - from my understanding savings rate is negative, so Im not sure where all these deopsits are actually coming from - probably just floating cash as pays go in and out.


EDIT: I also just read that some police chief from a small town got his pay switched to BitCoin - might prove to be popular given threats of bail ins and charges on deposits.

Thu, 12/05/2013 - 12:17 | Link to Comment Withdrawn Sanction
Withdrawn Sanction's picture

"Banks can only lend excess reserves to other banks or to the Fed..."

If they lend them directly, that's a true statement.  But the reserves are "excess" in that they are beyond what the bank's level of deposits require to be held in reserve.  So the article's point about "excess deposits," is spot on. 

IOW, the banks COULD choose to lend those excessively reserved deposits to ordinary borrowers (at today's uber low rates).  That they elect not to, tells you something.  And it is not that they can earn 25bp on excess reserve deposits at the Fed.  Even levered 10:1, that generates a tiny 2.5% ROE.  Yeah, yeah, risk free and all that, but most bankers wont get out of bed for 2.5%. 

I think it tells you instead, they are either making their nut elsewhere (prop trading springs to mind), and/or they're too afraid to lend traditionally.  The fear factor looms potentially large, as many are still reeling from bad loans not yet realized/written off/off-loaded to the Fed.  But perhaps just as important, w/rates this low, why lock in a loan portfolio at these levels.  That'd be a recipe for another disaster.

These numb nuts have boxed themselves in really well, it would seem. 

Thu, 12/05/2013 - 12:37 | Link to Comment kaiserhoff
kaiserhoff's picture

Hundreds of dead shopping centers, among other problems.

Commercial real estate is dying.

Thu, 12/05/2013 - 11:17 | Link to Comment theprofromdover
theprofromdover's picture

The lobbying failed????????????

I don't think I am quite ready to handle that.

The cornerstone of our democracy is the fact that lobbyists get to help the government understand what the people * want and need.


* the reeel peepel you know, corporations and banks. They're people too.

Thu, 12/05/2013 - 12:13 | Link to Comment the grateful un...
the grateful unemployed's picture

lobbyists write policy and policy is never wrong +100)

Thu, 12/05/2013 - 11:37 | Link to Comment Stockmonger
Stockmonger's picture

Regulators:  That's not my ass, that's a hole in the ground!

Thu, 12/05/2013 - 11:46 | Link to Comment yogibear
yogibear's picture

Easy come, easy go. Want to see some fun, trigger the trillions in derivatives to implode. 

Thu, 12/05/2013 - 11:50 | Link to Comment tradewithdave
tradewithdave's picture

Calling Bart Chilton. Calling Bart Chilton.

I thought Donk Fraud implementations were measured in dog years. Why the rush?

Thu, 12/05/2013 - 11:56 | Link to Comment tradewithdave
tradewithdave's picture

Think of it as a living will. Kind of like prepaid legal but for pet cremation services. Heck of a job cleansing Bear Stearns short silver via the so-called "whale." Click here for photos of Bruno Iksil.

Thu, 12/05/2013 - 12:21 | Link to Comment Catullus
Catullus's picture

Setting up the bond market collapse.

How is anyone supposed to hedge any of their long positions if there's no money to open the corresponding derivative position? I would imagine that most of those holding on to bonds think that they're hedged because they own a combination of IRS, FX and CDS. So while the nominal outstanding derivative exposure decreases, you backup the risk back into the underlying.

I agree with the argument that if you wouldn't have allowed this to begin with, the bond market wouldn't have been as liquid. But that's neither here nor there any longer. You can't unbake this cookie without risk being repriced.

Thu, 12/05/2013 - 12:27 | Link to Comment I Write Code
I Write Code's picture

It was basically the mispricing of CDS that brought on the entire 2008 fiasco.

If this is an attempt to reprice it properly, IT'S ABOUT F'ING TIME.

Anything that then collapses, should.

Thu, 12/05/2013 - 13:01 | Link to Comment Catullus
Catullus's picture

I disagree with the first sentence. I don't think CDS was mispriced. I think the viability of AIG (the counterparty to the CDS transactions) was what caused that specific fear that the underlying CDOs weren't hedged for downgrade or default. For what it's worth, I don't think you can ever properly price counterparty risk because it has more to with an unquantifiable uncertainty related to a bimodal outcome (either default or not). Someone saying "they have a 30% chance of going tits up" is meaningless.

The relevant question now is whether the CDO market then would have been liquid if AIG were not allowed to underwrite CDS. If the answer is "no", then if the banks now are not allowed to use deposits for IM to open IRS positions, then would the treasury or corporate bond markets be liquid?

Thu, 12/05/2013 - 12:24 | Link to Comment I Write Code
I Write Code's picture

I can't tell from this report wtf is going on.  What's a hedge?  Banks "hedge" assets with liabilities, it's what they DO.  If there is some attempt to limit what kind of assets can be balanced against what kind of liabilities, well, that's fine (and long overdue for any institution backed by the US government and my tax dollars), but it is NOT a "limit on hedging", it would be a limit on what funds can be used on what instruments.

It would be a START on a revolutionary change, and one which I believe is long overdue, which is to REJECT the modern banker's idea that *risk* can be chopped up and moved around in some abstract ways.

Again, if anyone wants to take private money and play reindeer games with it, that's fine, but NOT when some public too-big-to-fail companies like Citi or Merrill or AIG or (ahem) Goldman et al have to be bailed out by tax dollars after the banksters award themselves billions in compensation for their mathematical fantasies.

Thu, 12/05/2013 - 12:26 | Link to Comment freedogger
freedogger's picture

"For once regulators and politicians not only understood the underlying issues but did the right thing"

Good job ZeroHedge calling it like you see it. Calling out all the BS over the past few years but still not afraid to mention positive actions when they do happen. 

Thu, 12/05/2013 - 13:17 | Link to Comment RaceToTheBottom
RaceToTheBottom's picture

The FED did not give the banksters the money for no reason what so ever.  It was being used for collateral on risky bets if nothing else.

Thu, 12/05/2013 - 15:07 | Link to Comment Fishhawk
Fishhawk's picture

This is theatre; either a)the regulators are extorting the banks for a bigger kickback cut, or b)the banks are putting up a straw man to show that they are being effectively limited by the regulators.  Most probably it started out as a) and then morphed into b) when the banks saw a way to make some hay in advancing the social meme that the banks can be regulated.  Since the banksters own (and have owned for decades) the government, we can be sure it is theatre, since the banks are not going to allow regulations to slow their looting of the assets of the country.  The banks now control the nation's money, so they can buy anything else they need to maintain control.  Move along, nothing to see here. 


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