–JPM Losses, LIBOR Rigging Show ‘Low-Road Business Models’ Persist
By Brai Odion-Esene
WASHINGTON (MNI) – Federal Reserve Board Gov. Sarah Bloom-Raskin
Monday night slammed the limited exemptions included in the proposed
regulation banning proprietary trading by banks with a government
backstop, arguing that proprietary trading has a “low or no real
economic value.”
And at a time when the financial sector is again under fire for
unscrupulous practices, the former Maryland Commissioner of Financial
Regulation did not mince her words, describing the LIBOR-rigging
scandal, and the trading losses from JPMorgan’s failed bets, as examples
of “low-road business models.”
In prepared remarks to the Graduate School of Banking at Colorado
University in Boulder, Colorado, Raskin focused her comments on banking
regulation and did not comment on the economy nor monetary policy.
She noted that when making decisions, banks are faced with taking
the high road or the low.
“The high road offers a way to do business and to succeed over the
long term by building enduring relationships; structuring profitable,
win-win arrangements; and treating customers and communities as
meaningful stakeholders in the bank’s work,” she said.
But, Raskin added, “sometimes choosing this high road just doesn’t
seem to take us where we want to go fast enough. Suddenly, the low road
can seem attractive and tantalizing, and it may offer short-term rewards
that can be hard to resist.”
“The low-road banking model leads to a series of business choices
emanating from a business plan and culture focused largely on quick
profits with little consideration of longer-term risks and costs, not
only to individual firms, but also to the financial system more
broadly,” she said.
The model, Raskin continued, implies indifference to the
consequences of poor risk management, executive compensation schemes
that encourage “unmitigated and unmonitored” risk-taking, and reliance
on taxpayer money to save banks “from their own folly and the injuries
that their folly creates for the people of our country.”
And while not naming the culprits directly, “We know that low-road
business models exist and persist: for example, when we hear about
billions of dollars of losses resulting from what were supposed to be
conservative hedging strategies, or about the manipulation of key market
interest rates,” Raskin said.
She argued that new regulation, when crafted appropriately, can
effectively alter the actions of those banks that follow low-road
business models, although it is not without cost.
“Indeed, some banking models are so complicated that they cannot be
regulated without the expenditure of significant public or private
dollars,” Raskin said. “When these business models have such a distant
connection to meaningful financial intermediation, I believe that we as
a society may very well want to rethink whether we want to support these
business models at all.”
“Certain capital market activities for federally insured banks
should not be supported by vast amounts of public and private
expenditure,” Raskin added.
Proprietary trading by such financial institutions, for example, is
a capital markets activity that Raskin said is “quite distinct” from the
prototypical banking relationship that allocates financing from
depositors to projects that produce value.
“I view proprietary trading as an activity of low or no real
economic value that should not be part of any banking model that has an
implicit government backstop,” she said.
Raskin said proprietary trading involves buying and selling purely
for speculative purposes that have little to do with a true assessment
of a bank’s underlying value.
“This hyper-liquidity, motivated by nothing more than expectations
of short-term price movements, creates inefficient subsidies to buyers
and sellers with no compelling public benefit,” she said.
When Congress crafted the Volcker Ruler prohibiting proprietary
trading by banks, lawmakers included limited exemptions, permitting
activities if they constituted hedging or market-making and posed no
risks to the system.
It is these limited exemptions based on safety and soundness and
financial stability, or “guard rails”, that Raskin takes issue with.
She cited the potentially severe dangers of, and costs associated
with, proprietary trading by institutions that have access to the
federal safety net.
“In fact, it is not inconceivable to think that the potential costs
associated with permitting hedging and market-making within these
exemptions still outweigh the benefits we as a society supposedly
receive from permitting these capital market activities,” Raskin said.
“The potential compliance, supervisory, and other costs could be so
great as to eliminate whatever value may arguably be derived by virtue
of these capital market activities,” she added.
Raskin said she dissented in the vote for approval of the proposed
implementation of the Volcker Rule because her sense was that the guard
rails were insufficient and would allow banks to be able to go too far
off the road.
“Further, I was concerned that the guard rails as crafted could be
subject to significant abuse — abuse that would be very hard for even
the best supervisors to catch,” she said.
Raskin noted that the Volcker Rule focuses solely on
government-backstopped banks and their affiliates, meaning that even if
FDIC-insured banks are banned from market-making, these markets would
still be supported by conventional investment banks, hedge funds, and
other financial market participants.
“Thus, any supposed impact by the Volcker Rule on overall market
liquidity or credit spreads is, to me, questionable,” she said.
** MNI Washington Bureau: 202-371-2121 **
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