Monday, December 22, 2014

The Fed Lets Banks Continue Risky Trades: Too Big To Fail Ensconced

In December 2014, the U.S. Federal Reserve Bank granted banks an extra year past the July 2015 deadline to comply with a major provision of the Volcker Rule requiring the banks to unwind investments in private equity firms, hedge funds, and specialty securities projects.[1] The Fed also announced that it would give the banks yet another year to hold onto their positions. The Fed’s rationale points to an underlying conflict of interest facing the Fed, a banking regulator arguably  too vulnerable to the banks’ lobbying muscle.

Banks pled that dumping holdings quickly would mean having to accept discount prices. “There’s considerable pressure the Fed is feeling in that they don’t want institutions to have a bloodbath trying to divest funds,” Kevin Petrasic, a partner in a global banking practice, said.[2] At the time, Goldman Sachs had $7 billion invested in private equity that the bank might have had to sell for a loss had the extension not been granted.[3] For Morgan Stanley, $2.5 billion is said to have been vulnerable to being sold at a loss. These figures presumably come from the banks themselves, and reliance on the regulated for information is part of what goes into regulatory capture of an agency by the firms being regulated.

Dennis Kelleher, of Better Markets, claimed the “Street has had years of notice to unwind these investments, and it appears that their self-serving complaints have been accepted fairly uncritically without a real analysis for the basis of the claim.”[4] That is to say, relying on both the information provided by the regulated and their interpretation puts the Fed’s regulatory function at risk—and hence the financial system itself at risk. Interestingly, Kelleher sounds more like a regulator than the Fed in observing, “If you can’t get out of a trade in seven years, it’s probably not the kind of trade you should be doing.”[5] The “regulators” at the Fed seem to have rolled over, taking the “self-serving complaints” at face value—ignoring the obvious problem in doing so. At the very least, regulators at the Fed should have assumed that the information would naturally be skewed; from such a perspective, a critical examination would have been an obvious necessary step prior to any decision to give the banks another year.

In short, the Fed comes off looking rather naïve, though underneath the reality could actually involve the banks having too much control over top Fed officials—the banks having a significant role in the appointing process. As a result, eight years after the financial crisis of 2008, risky proprietary trading was alive and well on a street populated by banks even more so too big to fail. Beyond the question of cozy relationships between the Fed and the banks that it regulates, the lack of any public outcry points to a problematic learning-curve societally in the U.S., with disturbing implications on the ability of a people to self-govern. Yet the alternative would seem to be more cronyism divested of any risk of being made transparent.

1. Zach Carter, “Fed Delays Volcker Rule, Giving Wall Street Another Holiday Gift,” The Huffington PostDecember 18, 2014.
2. Jesse Hamilton, Ian Katz, and Cheyenne Hopkins, “Goldman Needs Volcker Delay to Avoid Private-Equity Losses,” Bloomberg, December 5, 2014.
3. Ibid.
4. Carter, “Fed Delays Volcker Rule.”
5. Ibid.