Reckless bankers undercut reform

Posted: Thursday, March 18, 2010

Bankers should be a humble crew. Their reckless trading almost ruined the world economy. But they are as arrogant as ever.

While bank chiefs pay lip service to reform, their lieutenants in the trenches resist government attempts to prevent future financial disasters with the same old Chamber of Commerce gusto.

Bank lobbyists in Washington, for instance, have their cannons aimed at the proposed Volcker Rule, which would prevent banks from trading for their own account and from running hedge and leveraged-buyout funds.

The prohibition, named after its proponent, former Federal Reserve Chairman Paul Volcker, would mitigate the use of bank deposits to take inordinate risks, such as gambling on subprime mortgages with gobs of borrowed money.

A ban on proprietary trading won't work, the banks say, because it's hard to separate trades they make for themselves from ones they make for customers. Do they mean that the math geniuses they have on their payrolls couldn't figure it out?

Banks insist on the status quo because taking risks is where the big profit and the huge bonuses are. That's why commercial banks a decade ago got the law changed to allow them forays into investment banking.

This is the system that Wall Street wants to keep: One where Richard Fuld, who as chief executive officer of now- bankrupt Lehman Brothers Holdings, signed off on misleading financial statements, making himself "at least grossly negligent," according to a court-appointed examiner's report last week.

This is the system that Wall Street wants to keep: One where CEO Lloyd Blankfein sees nothing wrong with Goldman Sachs Group having made trading bets against the very investments it had sold to customers.

This is the system that Wall Street wants to keep: One where JPMorgan Chase got so caught up in the profit possibilities for mortgages that CEO Jamie Dimon told a government panel in January, "We never questioned that home prices would not go up forever."

Bank CEOs support a new government body that would wind down failed big banks in a way that wouldn't upset the financial system. They prefer not to think about a better option: Separating investment banks and commercial banks again and making sure no institution gets too big.

Banks also fight against proposals that the trading of derivatives - contracts that companies and investors use to hedge risks - must be on exchanges. That would mean guaranteed trades made openly by firms with adequate capital.

Financial lobbyists say it's not practical to trade all derivatives on an exchange because in many instances, banks have to customize hedges for certain risks. Looks like another worthy job for those Wall Street Ph.D.s - hedging a one-of-a-kind risk with generic contracts.

Banks maintain that derivatives didn't cause the credit crisis. Apparently, derivatives - in this case credit-default swaps that were insurance on bonds - didn't cause the collapse of American International Group Inc. and the massive government bailout of that insurance company.

Giant banks resist derivatives reform because they fight anything that fosters disclosure. Information about their trades makes for more efficient markets. Banks make more money in inefficient markets; the combination of opaque pricing and their own information gives them an advantage.

Clamping down on the banks should be a no-brainer given their low standing with the public. Yet bankers still get a hearing when they try to undercut reforms, if not defeat them. In the end, it may be business as usual on Wall Street. Bank CEOs gloat at the prospect.

• David Pauly is a Bloomberg News columnist.

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