WASHINGTON - 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 anipulation 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.
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