In a recent BankThink post challenging the rationale behind the Volcker rule, Richard E. Farley suggests that not a single bank collapsed because of proprietary trading in the last crisis.
Preposterous.
Responding to Paul Volcker's public comment letter on the proposal named after him, Farley complains, "What he does not tell us, because he cannot, is the name of a single bank that went under and required taxpayer support because of proprietary trading gone bad."
Paul Volcker is a busy man, but I can name at least four institutions that effectively "went under" and required taxpayer support because of proprietary trading gone bad: Citigroup, Bank of America, Morgan Stanley, and Royal Bank of Scotland.
The question of whether the three U.S. firms could have survived without Washington's support is succinctly answered in the Oct. 5, 2009 report by the Special Inspector General of the Troubled Asset Relief Program. The title says it all: "Emergency Capital Injections to Support the Viability of Bank of America, Other Major Banks, and the U.S. Financial System."
The government has also provided the details of the desperation at these and other institutions in a huge disclosure of daily borrowings by 1,305 institutions from the Federal Reserve.
The data consists of every transaction reported by the central bank as constituting a "primary, secondary, or other extension of credit" by the Fed. Included in this definition are normal borrowings from the Fed, the primary dealer credit facility, and the asset backed commercial paper program. These borrowings did not include the Trouble Asset Relief Program announced in October 2008.
My firm sifted through more than 200 pdf files and compiled a database of daily borrowings and their respective maturity dates from Feb. 8, 2008 to March 16, 2009. We calculated the maximum and average borrowing for selected institutions after deducting matured amounts on the maturity date.
It is obvious from the results that Citibank, Bank of America, and Morgan Stanley were hurting for funding during this period.
Citigroup's borrowings, even after capital-raising attempts, were $24.2 billion at its peak. The consolidated borrowings for Bank of America and the two troubled institutions it acquired, Countrywide and Merrill Lynch, peaked at $48.1 billion and averaged $14.1 billion in outstanding balances. Morgan Stanley had peak borrowings of $61.3 billion and average outstanding borrowings from the Fed of $16.1 billion.
Even the reputedly exceptional JPMorgan Chase, when consolidated with Bear Stearns and Washington Mutual, had astonishing borrowings, peaking at $101.1 billion and averaging $23.6 billion.
What about Royal Bank of Scotland? Most of its borrowings from the Fed came through a different program, the commercial paper funding facility. Even while the U.K. government was injecting 45.5 billion pounds sterling of equity capital, RBS’ borrowings from the Fed facility peaked at $20.46 billion.
Let's not get hung up on semantics, though. Suppose we concede that, since the rescues prevented failures, the institutions did not technically "go under." The more important question is whether proprietary trading caused their near-failure.
What is "proprietary trading?" The plain English explanation would not be "trading for one's own account" because banks have done that for decades. In the current context, the phrase means "trading in high risk instruments." Former Fed chairman Volcker's rule is based on the premise that the effective subsidy of deposit insurance should not facilitate a large New York bank’s attempt to manipulate the silver market, for example.
Another problem with this analysis is the failure to distinguish between mark to market losses and actual loan or investment losses. I know of one bank that had some significant write downs of its loan portfolio because it booked all its loans as held for sale. The actual loan losses were negligible. Eventually all but one loan in a $7 billion portfolio paid in full as agreed.
The whole debate over Volcker is muddled because Volcker made it that way. He wanted people to think -- wrongly -- that proprietary trading desks at large securities companies were using federally insured deposits to take big risks. The weren't. When the trades actually made by the federally insured banks are better understood Volcker's real agenda becomes clear -- to reinstate Glass Steagall through the back door.