Out from the IRA is an interesting piece taking a shot at Volcker's reform proposals:
If you accept that situations such as AIG and other cases where Buy Side investors (and, indirectly, the US taxpayer) were defrauded through the use of OTC derivatives and/or structured assets as the archetype "problems" that require a public policy response, then the Volcker Rule does not address the problem. The basic issue that still has not been addressed by Congress and most federal regulators (other than the FDIC with its proposed rule on bank securitizations) is how to fix the markets for OTC derivatives and structured finance vehicles that caused losses to AIG and other investors.
Well, actually it does partly fix the problem.
IRA gets the cause correct: we got into this mess as a consequence of intentionally-opaque financial instruments that were less-than-honest in both their intentions and disclosures.
But where IRA misses the market is that they have not discussed who was it that came up with these structured financial instruments, who assembled them, who wrote the prospectuses, and who bought ratings for them from the ratings agencies?
Why that would be "the big banks", right?
Remember, Wachovia wrote off-balance-sheet swaps against their own securitized mortgage deals when they found them unmarketable "as written."
Goldman, Merrill, Morgan, Bank of America, Lehman, Bear and others created the securitized mortgage conduits and structures for non-agency paper and in fact stuffed into Fannie and Freddie securitized loans that did not meet the GSE's actual mandate in terms of disclosure and underwriting - that is, they sold them purely on the basis of a rating.
Despite warnings from the FBI in 2004, Comscore in 2006 and HUD in 2007, all of which warned of extraordinary levels of fraud in these instruments and two of them - Comscore and HUD - making the claim that as many as nine in ten ALT-A loans were made to people who did not have the income and/or assets they represented, there was no disclosure of these facts in the offering prospectuses for the securitized debt generated from these "loans."
IRA points out:
A decade since the Enron-WorldCom scandals, we still have the same basic problems, namely the use of OBS vehicles and OTC structured securities and derivatives to commit securities fraud via deceptive instruments and poor or no disclosure. Author Martin Mayer teaches us that another name for OTC markets is "bucket shop," thus the focus on prop trading today in the Volcker Rule seems entirely off target -- and deliberately so. The Volcker Rule, at least as articulated so far, does not solve the problem nor is it intended to. And what is the problem?
Not a single major securities firm or bank failed due to prop trading during the past several years. Instead, it was the securities origination and sales process, that is, the customer side of the business of originating and selling securities that was the real source of systemic risk. The Volcker Rule conveniently ignores the securities sales and underwriting side of the business and instead talks about hedge funds and proprietary trading desks operated inside large dealer banks. But this is no surprise. Note that former SEC chairman Bill Donaldson was standing next to President Obama on the dais last week when the President unveiled his reform, along with Paul Volcker and Treasury Secretary Tim Geithner.
The argument that we have not solved these issues is a good one, but again misses the mark in that one must ask: why would an institution create these things unless they were able to force someone else to eat them when they go bad?
I would argue that while IRA certainly has the "long view" correct (and in fact it is almost exactly what I've been arguing for since I began publishing The Market Ticker) in point of fact separating securities businesses from deposit and loan -making in all of its forms is in fact a positive change, in that it will remove the backstop that these firms otherwise immediately run to whenever someone proposes to do something (like make them eat their fraudulently-created securities) that might threaten their survival.
As such while "The Volcker Rule" certainly won't fix the world, it will in fact change the landscape in a fashion that will make possible the imposition of strict liability for the creation of fraudulent securities in all their forms, including the "corporate death penalty" sanction that, at present, we are told cannot be applied without destroying both the banking system and economy.
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