The Fallacy Of The Volcker Rule (Or "Fixing" The Banks In 5 Easy Steps)

Tyler Durden's picture

Submitted by Peter Tchir of TF Market Advisors,

Volcker Rule - Who cares?  I know we are supposed to care more about this convoluted rule, but we just can’t.

The concept that somehow “prop” trading brought down the banks seems silly.  The idea that market making desks were a dangerous part of the equation is ludicrous.

They could have fixed this with a few simple changes, but that would have meant some blame would have had to be shifted onto the regulators...

The inability of regulators to communicate and create consistent rules had more of an impact than anything else.  The single biggest problem was that the insurance rules and bank rules did not line up.  Banks could load up on AAA tranches of ABS CDO’s (including sub-prime) and buy protection for companies that could never hope to pay it off if it went wrong and attract almost no regulatory capital.  The entity that sold it would run some actuarial models and also have no regulatory capital.  At some point the regulators allowed some AAA risk, which should have attracted significant capital, to attract none.  Making the insurance regulators and bank regulators communicate and close loopholes would be a simpler and more effective solution than Volcker.

The rest could be fixed by a few simple hires.

First, hire a junior person from the risk management side of any mediocre hedge fund.  They would immediately want to put in place some limits on gross notionals.  Yes, hedging and relative value is potentially profitable, but you still want to limit the size.  That would reduce curve trades, the unnecessary proliferation of back to back derivative trades, etc.  It would help ensure that the “worst case” isn’t so bad or so convoluted that investors get too nervous.


Second, hire a junior level accountant.  They could quickly realize that when some massive percentage of the P&L is driven by model risk (correlation trading for example) you should be nervous.  Limit the amount of risk offset that can be derived from models and do the same with P&L.  It is great that banks can use their models for capital requirements and to a large degree it makes sense, but models are notoriously wrong – sometimes by accident, sometimes because no one knows better, and sometimes on purpose.  Don’t eliminate the use of models, but keep it to a size that is reasonable.


Third, hire someone from the IRS.  Make a “progressive” capital system.  Charge more as the size of a position increases.  Owning $25 million, $100 million and $250 million of the bond is not usually linear.  In most cases owning $250 million is more than 10 times riskier than owning just $25 million.  This applies to individual holdings and a portfolio.  Too big to fail would yelp but that is the reality and would be much simpler than what we got.


Fourth, hire a retired mid-level commercial banker from the 80’s.  They can remind everyone that lending is risky and that banks have blown up in the past based on dumb loans, no mark to market accounting, and inadequate reserves.  Banks don’t need these newfangled inventions to blow themselves up – they were capable of blowing themselves up in the exact sort of environment Volcker seems intent on dragging them back into.


Five, fire 1,250 lawyers.  The ratio of lawyers to people who know their way around trading or risk is absurd.

In the end, banks are taking less risk because they don’t want to.  If and when they want to, they can probably find a way.  The Volcker rule is overly complex.  Banks will shy away from activities for now.  That is probably bad for bank stocks at the margin but remains good for bank credit as tail risk is pushed off (at least until they get bloated on bad loans, but that is years away).

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Occident Mortal's picture

Pay banker bonuses in CDS, problem solved.

Captain Willard's picture

Well, as you may recall, UBS and Credit Suisse paid their bonuses in the form of the so-called "toxic crap" after the Crisis of 2008. This is similar to your idea.

So what happened? We got Quantitative Easing and this toxic crap mostly traded back to par. The bankers won again!! They even screwed their own shareholders in the process.

Your heart is in the right place. But unless we're prepared to let these firms go under in the next crisis, the bankers will always win.

Occident Mortal's picture

No, pay them in credit default swaps when times are good. You know before the crash.


The scenario you suggest is locking the door after the horse has bolted.

I don't see the point in paying them in distressed assets in the midst of a financial crisis, unless you wanted to motivate them to lobby for a bailout of those assets, you know like TARP.


If you pay bankers in CDS the creditworthiness of the banks would improve overnight, and within a week they will be strong enough to survive a depression.


Banks shouldn’t exist to skim a profit from the economy, they should exist to protect capital from financial risk.


We should motivate them accordingly. Tie their net worth to the creditworthiness of their bank and then see how they act. Their compensation shouldn't be tied to forward earnings, it should be tied to creditworthiness.

Captain Willard's picture

I think we're in agreement. I didn't advocate anything; I merely reported what two big banks did. It's a complex problem unless you're prepared to eliminate deposit insurance.

Your point about paying them in CDS in good times still won't work if you're not prepared to let them actually default and trigger the CDS, as you must know. Such a default would have negative externalities in many cases. Perhaps it's worth taking the chance.

I think you're on the right track. I don't have the answer. But I think it's a combination of changing or eliminating the deposit insurance regime, raising more contingent capital and of course changing compensation plans, as you correctly suggest.

dracos_ghost's picture

Captial punishment. The other white meat.

As others have said, let them fail. What is it with the circle jerking that banks have special position in human society that they need to be taken care of at all cost. Gee, so over time they've been given:

1)Monopoly CB Powers operating outside sovereign laws.

2)Mark to Unicorn powers to hide dump trades and defraud investors.

3) Fractional Reserve capabilities so when they do tank they get to ruin the lives of people for pennies on the dollar.

4) Rights to rehypothecate with no repercussions.

5) Right to illegally strip off mortgages and then when they tank the holder of the mortgage gets banged but the bank gets covered.

End of the day, it's all our fault for allowing this shite.

fonzannoon's picture

(at least until they get bloated on bad loans, but that is years away).



RSloane's picture

So the next step obviously is hire a fall guy whose lack of intelligence and diligence will safely provide the shadow under which financial institutions will continue their operations as if the Volker rule never exiisted, and go to prison when/if the financial institution is caught breaking the rules.

Like having a wisdom tooth removed without anesthetics, this is going to be so much fun.

RSloane's picture

I'm sure he meant in Palmetto bug years or flee years.

Dr. Engali's picture

What a load of crap. You want to fix things? Allow the fuckers to fail when they fall on their faces. That will put an end to their crap. Anything short of bankruptcy is just another rule for the banking parasites to expoit and finagle their way around.

NoDebt's picture

Agreed.  Exactly my point as well, below.  All this crap to try to prevent failures that are going to happen anyway, somehow, someday.  You'll get a lot better risk management with a deep understanding and appreciation of their own institutions' mortality.

Right now, even today, I think all of them have an abiding faith they would be bailed out again tomorrow if they got in trouble. 

alien-IQ's picture

Perhaps it's due to the fact that I don't run with people in such lofty financial perches. I don't know. But I have never encountered anyone at a party that made the defense being made in this article. I know this to be a fact because I cannot recall ever having cracked a beer bottle over someones head at any party.

Dr. Engali's picture

I have heard a lot of B.S in my lifetime and this one is near the top of the list. Just once I would like to meet a person who writes an article like this so I could rip them to shreds.

texas sandman's picture

This thing reads like an Onion article.....sure someone didn't forget their /sarc tag?  If not, take no advice from these "market advisors".

11b40's picture

Like the rest of things in this life, it all depends on whose ox is being gored.

Obviously, Mr. Tchir is worried about his ox getting bloody.

NoDebt's picture

"Perhaps it's due to the fact that I don't run with people in such lofty financial perches."

Yes, that's exactly why.  If you did you'd be nodding your head up and down in agreement right now.

Wall St. has become it's own ecosystem now, like DC has been for a long time.  If we've learned anything the last few years it's that they take care of their own and the 'real economy' (if there is such a thing) has only the mildest effect on them.

TwoCats's picture

"I know this to be a fact because I cannot recall ever having cracked a beer bottle over someones head at any party."

I truly enjoyed your reasoning.  It was straightforward, logical, and concise.  Bravo and +1.

RSloane's picture

That's just a dream, Doc, brought about by your instincts of fair play and justice. Nothing is ever going to happen to the banks. If you want proof, I can link dozens of pics of Obama and Dimon or a congressman and Blankfein. Or links of Jamie being called "the banker's banker" in the most flattering of terms.

It will never end until there are more than two parties running for government. Not just the presidency, all seats in congress as well. Its much harder to buy off politicians when there are four or five of them versus two. The banks will not be allowed to fail for a couple of reasons: 1] thousands of small independent banks who could not compete with zombie banks have been closed so power resides in the remaining banks 2] political campaign contributions trump justice, and 3] the league of banks is international. Any laws we might have can be completely ignored in the international divisions of our banks.

Good to see you Doc. The only thing too big to fail right now is the US government. IF we want that to happen we are all going to have to work for it.

Kayman's picture

"The only thing too big to fail right now is the US government."

These guys are burning the furniture to keep the house warm. Without private income streams, this party will end.

Dr. Engali's picture

I'ts good to see youn too Sloan.Yeah I know it's a pipe dream . The whole thing is way past saving (not that I want it saved), and I'm getting tired of waiting. While we wait, they are taking aggressive actions to put us in our place.

Stuck on Zero's picture

If you want to fix things break the ten largest banks up into fifty pieces each and declare caveat emptor to savers and depositers.  Only state regulated and chartered banks would be allowed in the future.


Kayman's picture

Separate commercial banking from so-called investment banking and have the investment bankers put their own personal capital only as security for derivatives.

I can still dream, can't I ? 

gallistic's picture

The union of commercial banking and investment banking is the key reason for the emergence of "too big to fail" institutions. Call me a simpleton or a caveman, but in order to "let them fall on their faces" the banksters cannot control the savings of ordinary Americans, they cannot have their tentacles in certain areas of the economy, and they cannot be FDIC insured.

The answer was as clear in 1933 as it is now. We had a law that was only about 50 pages long (versus 900 for the "Volker rule") and served us well for decades. Slowly and surely, the finance industry and federal regulators chipped away at this law until Slick Willie and a compliant, bought-off Congress finally repealed it.

The people can huff and puff, but unless the clear, simple, unambiguous, core separation provisions are re-instated as the law of the land, these institutions will never be allowed to "fall on their faces".

I have not read the 900 pages, and I am fairly certain I will not. I am, however, cynical enough to believe its complexity is by design. The currently watered down Volker rule is an ineffectual and timid measure and the exceptions to proprietary trading are numerous.

Apparently, the Volker rule includes exemption provisions for "underwiting", "corporate client undertaking", "Market making activities", "Risk mitigated hedging", "proprietary trading in government instruments", "Trading activities in foreign sovereign securities", and "foreign banking securities". My personal favorite is the "liquidity management" provision where banks are permitted to hold any positions to ensure their near-term liquidity or cash needs.

“Here’s the key word in the rules: ‘exemption,’... Let me tell you, as soon as you see that, it’s pronounced ‘loophole.’ That’s what it means in English.”

Former Delaware Senator Ted Kaufman

Definitions matter. What the hell does any of this truly mean? Who defines what constitutes these activities and what doesn't? When are you holding a position to be a market maker? What constitutes an accurate explanation of the letter or intent of the rule? When are you holding a position as a hedge? How do overwhelmed regulators enforce these byzantine provisions?

There are endless questions raised by this "rule". There will be a million ways for banksters to work the loopholes, "innovate", and get around it. This is by design.

What a fucking farce!


“I’d write a much simpler bill. I’d love to see a four-page bill that bans proprietary trading and makes the board and chief executive responsible for compliance. And I’d have strong regulators. If the banks didn’t comply with the spirit of the bill, they’d go after them.”

Paul Volker, Former Fed Chairman

Yardfarmer's picture

sixth, get a couple yards of rope, take tall Paul, and make him a foot taller.

11b40's picture

I suggest ignoring 1-4, implementing 5, then bringing back Glass-Stegal.

alien-IQ's picture

"The concept that somehow “prop” trading brought down the banks seems silly.  The idea that market making desks were a dangerous part of the equation is ludicrous."


Is this a fucking joke or was it written by a banking lobbyist?


DaveyJones's picture

The Ghost of Propdesks Past: William Barrings

Seasmoke's picture

Chris Sucks Cox. 

NoDebt's picture

How about this: when one of them goes tits-up we don't put them back in business again.  Don't even need regulation to accomplish that.

DaveyJones's picture

mother nature's regulation

she's been at it forever

and no kid is her favorite

Dr. Engali's picture

Come on taper you pigs. Kill this market so I don't have to buy a sandwich in six months.

fonzannoon's picture

Lol I was just having some fun with Tyler because twitter certainly got a lot of headlines when it was dropping. With that said I am fairly confident where everything else is, twitter will be below the opening price.

NoDebt's picture

I'm lost.  What got bet here?

Dr. Engali's picture

Fonz and I bet a lunch on Twitter's price 6 months from the opening price. I took the under and Fonz took the over.

NoDebt's picture

Oh, I see.  Maybe you should have just bet on sun spots or something a little more predictable and better understood.

And, by the way, taper isn't going to save you on this one, even if it happens.  You're staring down the barrel of a total random number generator, I think.

RSloane's picture

We're all going to end up owing Kito enough sandwiches, with Hearts of Romain lettuce and Havarti cheese, that he won't have to buy food for a year.

Dr. Engali's picture

I'm sidelining this fed meeting. There are too may variables. I don't believe they will taper, but they just may make a courtesy flush to save old Yeller from stinking up the place.

OneTinSoldier66's picture

How about End The Fed so the Banks don't have a backstop and have to stand on their own two feet? Or is that just too gd simple!?



DaveyJones's picture

"The single biggest problem was that the insurance rules and bank rules did not line up."

that's funny they both seem to avoid the rules

and their consequence

OneTinSoldier66's picture

And we're supposed to believe that the Volcker 'rule' will fix that. Lol

PT's picture

But that would involve hiring four people.  And the banksters got big bonuses for not hiring those four people.

6.  The "free markets" actually did a terrible job of deciding how much money people could borrow.  Have a simple rule like, "Don't lend money to people who can not afford to repay it."  eg "Don't lend more than mortgage repayments = 30% of net income."  If the markets were truly "free" then that law would never be used.  If too many people want to borrow more, then that is a sign that the markets are no longer free and need to be sorted out.

williambanzai7's picture

I think the Volcker Rule has taken on a whole different significance. My rewrite of the Volcker Rule: In the long run, he who has the most cash dripping lobbyists wins.

PT's picture

When someone, who does overtime to earn 600 bucks per week, buys a house for 400 grand, what more could you possibly need to know to figure out there is a hell of a huge problem???

Renewable Life's picture

Exactly, you just nailed it, 90% of Americans "earn" $600 a week after taxes OR LESS, the fucking numbers just dont add up anymore, but the banks still need to bonus record cash to their people, so they can pretend to be the smartest, highest paid fucks in the room! So what do you do, just make shit up and do it anyway! America post 1987 (Greenspan and Bernucklehead) knew the shit didnt add up, but they have no real ideas or reasons for it they can stomach, so we go on any day making shit up as we go!

PT's picture

We've had ~ 13 years where anyone who could see the problem was fired for under-performance, passed over for promotion or quit of their own accord.  We now have 13 years of what in the industry?

ebworthen's picture

The "Volcker Rule" is another term for people to hang onto to try and believe that our society isn't a complete lie.

Add it to "ACA", "SS", "DOJ", "SEC", "FTC", and every acronym and catch phrase that says one thing but means another.

Don't forget to salute J.P. Morgan Chase when you drive by, THAT is your government.

yogibear's picture

The only rule for the bankster is to make as much as you can.

Regardless if you cheat and or steal to do it.

Nobody in the Too Big To Fail banks has gone to jail for illegal financial activity. 

All the financial regulators are window dressers.


Dre4dwolf's picture

I can fix it:

Rule Number One:

Banks can only lend money they have on deposits, and fractional banking is no longer allowed.


Rule Number Two:

Banks are not allowed to gamble with Insurance Companies against the loans they make.


Rule Number Three:

Banks can not issue prefered shares, only common stock, and bonds are limited to sums not exceeding 45% of deposits.


Rule Number Four:

Bank CEOS can not take a bonus exceeding 15% of their lowest paid workers wage.


Rule Number Five:

Banks can not issue derivatives, or fabricate convoluted securities.


Rule Number Six:

Banks must actually loan the money to borrowers, Deposit that money into the borrowers private checking account, and then the borrower can purchase a property to back the loan.


The bank must purchase the property, and sell it to the borrower for a monthly payment.

No more of this "Back the loan with a property you do not own, in order to buy the property you do not own while I fabricate money out of thin air and put you in a position where you lose no matter what"


Rule Number Seven:

Banks must pay dividends (NOT INTEREST) to depositors, depositors will be issued dividends based on their average yearly balance.


Rule Number Eight:

If a bank takes ownership of real property, it has 180 days to sell the property, or the state will issue a fine equal to 65% of the properties value per year.


Rule Number Nine:

Banks are not allowed to participate in High Frequency trading, HFT is now illegal.


Rule Number Ten:

Banks may charge a fee for deposits not exceeding 1% per anum for deposits under 50,001%, and not exceeding 0.5% for deposits greater than 50,002.


Rule Number Eleven:

Banks that have failed, will sell off assets and distribute proceeds to depositors and common stock owners, with depositors taking priroity.


Rule Number Twelve:

Principal is now paid before interest on loans.

Rule Number Thirteen:

Any individual proven guilty of theft or fraud, will be executed publicly , and their assets will be re-distributed to depositors.

Violation of any of said above rules if not punished by death penalty, is punished by 70% of the violators assets being re-distributed to depositors and common share holders equitably based on % of deposits and shares owned.

Rule Number Fourteen:

All loans and related documents can not exceed 15 Pages of type 12 font on Legal Sized Paper (single sided).

If you can't say it in 15 pages, its probably fraud.

Feel free to add some rules.




virgilcaine's picture

Straight From the land of rainbows & unicorns.  Can one visit this magical place? Prop trading is but a symptom of a  much larger disease. Like the Corleone Family had a few sources of Income.. vice, gambling, pros, so does WS.