Good Work Charlie!

Charlie Gasparino works for Fox Business. Just highlighted a major weakness in the Volcker Rule.  This doesn’t surprise me, because the entire Fin Reg bill is a disaster.  It shouldn’t surprise anyone that there were plenty of loopholes in almost all the rules, since the revolving door between Wall Street, K Street and the Capitol incentivize loopholes.

Goldman Sachs is the first to exploit it.  In The Big Short, it was said that Goldman ran the playground and the banks played crack the whip all the way down to Merrill Lynch.  ML was the fat kid that picks his nose and eats paste.

I don’t blame the banks. I blame Chris Dodd and Barney Frank.  Lot’s of hot air and ink was expelled and they have got nothing but a larger bureaucracy to show for it.  Volcker also has egg on his face.

Here is the deal as outlined by Mr. Gasparino; If you become an asset manager and have contact with one client, you avoid the prop trading restrictions.  Send one email, the client responds-Bingo, you prop trade just like you used to.  Manage a couple of small accounts and you are in the clear.  Prop traders look like asset managers.  Please pass the Krug Champagne. Spill as much as you want!

In an analogous situation long, long ago, there was a group of traders that actually wanted to stop fraud rather than enable it. At the Chicago Mercantile Exchange, they had dual trading.  Locals, people that traded their own money for their own accounts, were peeved because it seemed like there was an awful lot of trading taking place on the top step of trading pits that they had no access to.  A minority of unethical brokers were taking the opposite side of customer orders and reaping huge profits off them-without any risk.  When an audit was conducted, it was found that in the financial pits, brokers were the top traders for their own account in virtually all of them.

There was a movement to ban dual trading in products that met a liquidity standard.  Eventually, it was hammered out that any product that had an average daily volume of over 10,000 contracts a day would have dual trading banned.  At the time, this 10k level was meaningful in an all open outcry environment.  Only the currencies, S+P, and Eurodollars were affected.

A loophole was put in the rule.  But, the loophole was far more onerous than the simple one in Fin Reg.  The broker had to contact each of a clearing firm’s clients and get permission to trade.  There was no way that was going to happen once the cat was out of the bag on the minority of bad eggs.  Essentially, the rule killed dual trading at the CME.  NYMEX and the CBOT never killed dual trading.

What happened?  Nothing. Volume exploded. Seat prices rose.  It can be heatedly debated as to who was right.  At CME, we experienced no slowdown, no lack of liquidity and still had really good markets.

This Fin Reg bill should have banned dual trading, and prop trading.  Then the loophole would have been gone. Traders would have left the banks and started their own hedge funds, or trading their own capital.  It’s really easy to make money when all you do is take the opposite side of customer orders all day.  That’s what a lot of them do.

It’s worth noting a couple of things. One, the ban of dual trading was an outgrowth of the FBI sting investigations that occurred in 1988-89. A period of self examination by the exchange, and members caused dual trading to be investigated. Secondly, the march toward the CME’s demutualization in 2000 began. The Equity Owners Association was started soon after the dual trading ban went into effect. They led the march toward real change at the CME. Lots of people rush to take credit for it, but there were really a minority of people behind it; William J. Sheperd, Don Karel, and Aryeh Shender began the main drive.

Banning prop trading and forcing it out of the banks will make markets fairer, more efficient, competitive and eventually lead to more volume.