Volcker (67 page)

22
. From an interview with Austan Goolsbee.

23
. See
Wall Street Journal
, November 8, 2008, p. A4, for the three contenders for the job as treasury secretary: former Clinton treasury secretary Lawrence Summers, Federal Reserve Bank of New York president Timothy Geithner, and Volcker.

24.
This story is from Austan Goolsbee. Buffett was born on August 30, 1930, which makes him three years younger than Volcker.

25
. The conversation is based on Volcker's recollection.

26
. For a discussion of the transition team, see
Washington Post
, November 6, 2008, p. A1, and November 14, 2008, p. A6; and
New York Times
, November 24, 2008, p. A1.

27
. See
New York
magazine, May 31, 2010, p. 25.

28
.
New York Times
, November 27, 2008, p. A29.

29
.
New York Times
, December 6, 1992, p. A1 continued. This quote also refers to the investment banker Felix G. Rohatyn, head of the Municipal Assistance Corporation in New York.

30
.
Wall Street Journal
, November 26, 2008, p. A4.

31
.
Washington Post
, November 27, 2008, p. A1.

32
. The Dodd-Frank Wall Street Reform and Consumer Protection Act, signed by President Obama on July 21, 2010, is named after Senate Banking Committee chairman Christopher Dodd and House Banking Committee chairman Barney Frank. The Volcker Rule prohibitions against bank proprietary trading activities and certain relationships with hedge funds are contained in Section 619 of the act.

33
.
Prohibiting Certain High Risk Investment Activities by Banks and Bank Holding Companies: Hearing Before the Senate Committee on Banking, Housing and Urban Affairs
, 111th Congress, 2nd Sess., Washington, DC, February 2, 2010, p. 3.

34
. Ibid., pp. 3–4.

35
. Volcker's key PERAB memo to Obama is contained in a cover letter dated June 2, 2009, supported by a statement on systemic risk dated June 3, 2009 (Personal Papers of Paul Volcker). The following excerpt on bank regulation forms the basis of what became the Volcker Rule: “Bank holding companies that engage in non-bank financial services, such as hedge funds, private equity funds, proprietary trading, and certain aspects of derivatives trading and other ‘transaction-oriented' services, subject their firms to complex risks and, to the extent they also serve customers in a fiduciary capacity, raise potentially unreconcilable [
sic
] conflicts of interest. Recent events have revealed that these threats, and the implications for the maintenance of management control, are very real and can have severe systemic consequences. As a result, banks should be discouraged from, and in some cases completely prohibited from, engaging in some risk-prone transaction-oriented capital market activities. It will not be necessary to return to Glass-Steagall, which prohibited some ‘relationship-oriented' services, such as underwriting corporate securities for business customers. However, some revision of Gramm-Leach-Bliley
will be required to reinforce protections against banking/commerce combinations and hedge fund or private equity fund sponsorships. The control of banks by individual hedge funds, private equity funds, or commercial firms should be prohibited.”

36
. See
Prohibiting Certain High Risk Investment Activities by Banks and Bank Holding Companies
, p. 49.

37
. See Paul Volcker op-ed, “How to Reform Our Financial System,”
New York Times
, January 31, 2010, p. WK1.

38
. PIPAV.

39
. See U.S. Treasury, “Financial Regulatory Reform: A New Foundation—Rebuilding Financial Supervision and Regulation,” June 19, 2009, available at
web.archive.org/web/20100623205517/
http://www.financialstability.gov/docs/regs/FinalReport_web.pdf

40
. Leverage enhances profits when prices rise but can lead to bankruptcy when prices decline. For example, suppose a family with $100,000 in savings pays that amount for a home a few miles outside of Cleveland or Dallas. A drop of $20,000 in the price of the house means a 20 percent loss on the $100,000 investment, but they still have a net worth of $80,000 and can enjoy the benefits of living close to downtown. A family with only $10,000 to begin with could also buy the same house but would have to borrow the remaining $90,000 to complete the purchase. After this
leveraged
transaction, the identical $20,000 price decline would turn the family's net worth from plus $10,000 to minus $10,000—the house is worth only $80,000, but they still owe $90,000. The price decline might even force the family to vacate the premises. Leverage can cause bankruptcy when asset prices decline.

41
.
Prohibiting Certain High Risk Investment Activities by Banks and Bank Holding Companies
, p. 22.

42
. Ibid., p. 21.

43
. Ibid., p. 22.

44
. See Markus Brunnermeier, “Deciphering the Liquidity and Credit Crunch of 2007–2008,”
Journal of Economic Perspectives
23, no. 1 (Winter 2009): 80–81. “In hindsight, it is clear that one distorting force leading to the popularity of structured investment vehicles was regulatory and ratings arbitrage. The Basel I Accord (an international agreement that sets guidelines for bank regulation) required that banks hold capital of at least 8 percent of the loans on their balance sheets; this capital requirement (called a ‘capital charge') was much lower for contractual credit lines.”

45
. See “Citigroup Says It Will Absorb SIV Assets,” MarketWatch, December 13, 2007, available at
www.marketwatch.com/story/citi-plans-to-absorb-49-billion-in-siv-assets-onto-balance-sheet
.

46.
This quote and the following quotes by Senator Johanns and Volcker come from
Prohibiting Certain High Risk Investment Activities by Banks and Bank Holding Companies
, pp. 26–28.

47
. For a detailed argument against the power of the Volcker Rule to prevent a crisis, and for arguments in favor of more capital, see Lawrence J. White, “The Gramm-Leach-Bliley Act of 1999: A Bridge Too Far? Or Not Far Enough?”
Suffolk University Law Review
43 (2009–2010): 937–56.

48
. Sorkin,
Too Big to Fail
, tells the Lehman story well.

49
. See “Dollar Hits Two-Year Low vs. Yen; Subprime-Battered Investors Pull Back from ‘Carry Trade,' ”
Wall Street Journal
, November 13, 2007, p. C2. Also see “Yen Gets Lift from Turmoil in the Market; Strength Amid Distress Reveals Investor Caution as Carry Trades Unwind,”
Wall Street Journal
, January 24, 2008, p. C1.

50
.
Prohibiting Certain High Risk Investment Activities by Banks and Bank Holding Companies
, p. 36.

51
. Shelby had asked “what constitutes excessive growth” at the largest financial firms? And Volcker gave the pornography answer. See ibid., p. 14.

52
. This quote and the remaining quotes in the chapter are from ibid., p. 37.

1
.
Guardian
, London, February 3, 2010, p. 22.

2
. The article is entitled “On the Nature of Trading: Do Speculators Leave Footprints?”
Journal of Portfolio Management
29, no. 4 (July 2003): 64–70. It was written in connection with my work as an expert witness in a legal dispute over a corporate takeover. The court case was
Consolidated Edison, Inc. v. Northeast Utilities
. I was retained by Shearman & Sterling on behalf of Consolidated Edison to provide deposition testimony and an expert report analyzing the nature of customer-based trading versus speculation. I applied that analysis to the behavior of the Northeast Utilities energy trading subsidiary in connection with Con Edison's bid to terminate its takeover of Northeast.

3
. I traded on the New York Futures Exchange, the COMEX, and the New York Mercantile Exchange as a scalper, or market maker, and wrote a paper describing that activity entitled “Marketmaker Behavior in an Auction Market: An Analysis of Scalpers in Futures Markets,”
Journal of Finance
39, no. 4 (September 1984): 937–54. I traded for a hedge fund called Odyssey Partners, run by Jack Nash and Leon Levy, from 1988 through 1996.

4
. The letter, entitled “Congress Should Implement the Volcker Rule for
Banks,” was signed by W. Michael Blumenthal, Nicholas Brady, Paul O'Neill, George Shultz, and John Snow, and appeared in Letters to the Editor,
Wall Street Journal
, February 22, 2010, p. A18.

5
. Brady (1988–1993), O'Neill (2001–2002), Shultz (1972–1974), and Snow (2003–2006) served in Republican administrations; Blumenthal (1977–1979) served in a Democratic administration.

6
. Milton Friedman was born on July 31, 1912, and died on November 16, 2006.

7
. See Bloomberg news report “Ex–Treasury Secretary Brady Running with ‘Volcker,'” at
www.nj.com/business/index.ssf/2010/08/ex-treasury_secretary_brady_ru.html
.

8
. Letter dated May 19, 2010, Personal Papers of Paul Volcker.

9
.
New York Times
, July 11, 2010, p. BU1.

10
. See John Cassidy, “The Volcker Rule,”
New Yorker
, July 26, 2010, p. 25.

11
. A copy of the 849-page bill, Public Law 111-203–July 21, 2010, is available at the online Government Printing Office with the following specific address:
www.gpo.gov/fdsys/pkg/PLAW-11publ203/pdf/PLAW-111publ203.pdf
.

12
. Public Law 111-203—July 21, 2010, 124 Stat. 1620.

13
. Ibid., 124 Stat. 1621.

14
. Ibid., 124 Stat. 1394. Section 111 of the Dodd-Frank Act established the Financial Stability Oversight Council (124 Stat 1392).

15
. The council consists of ten voting members and five nonvoting members. The voting members are the secretary of the treasury; the chairman of the Board of Governors of the Federal Reserve System; the comptroller of the currency; the director of the Bureau of Consumer Financial Protection; the chairman of the Securities and Exchange Commission; the chairman of the Federal Deposit Insurance Corporation; the chairman of the Commodity Futures Trading Commission; the director of the Federal Housing Finance Agency; the chairman of the National Credit Union Administration Board; and an independent member with insurance expertise who is appointed by the president and confirmed by the Senate for a six-year term. The nonvoting members, who serve in an advisory capacity, are the director of the Office of Financial Research; the director of the Federal Insurance Office; a state insurance commissioner designated by the state insurance commissioners; a state banking supervisor designated by the state banking supervisors; and a state securities commissioner (or officer performing like functions) designated by the state securities commissioners.

16
. See FSOC 2011 Annual Report, available at
www.treasury.gov/initiatives/fsoc/Pages/annual-report.aspx
, esp. p. 127.

17
. See Cassidy, “The Volcker Rule,” for a detailed account of the negotiations.

18.
See “Banks Dodge a Bullet as Congress Dilutes Rules,” Bloomberg, June 25, 2010.

19
. See
WSJ.com
, February 3, 2010, 9:16 P.M.

20
. Volcker's letter is addressed to Timothy Geithner as chairman of the FSOC, and is dated October 29, 2010. His footnote reads, “I understand that NYU Professor William Silber, who has served as expert witness in cases requiring identification of, and distinctions between, ‘proprietary' and ‘market-making' activity, is providing FSOC with relevant analysis.” My letter to committee chairman Timothy Geithner, dated November 2, 2010, included the following: “The methodology outlined in my paper can be applied to the ban on proprietary trading contained in Section 619 of the Dodd-Frank Act but it should not be viewed as a substitute for a comprehensive approach to implementing the Volcker Rule. In conversations with some of the staff at Treasury I have suggested that you instruct regulators to adapt the practical skills of managers in financial firms whose job it is to distinguish between speculation and market making. For example, during the years I spent as a trader on a number of futures exchanges I was impressed by the ability of my clearing firm to monitor each of their traders' risk exposure and to impose different capital requirements depending on whether the trader was a market maker or a speculator. The manager at the clearing firm looked at the sequence of a trader's transactions, the rate of inventory turnover, end-of-day positions, and then supplemented those numerical facts with surprise visits to the trading floor to see what a suspected ‘closet speculator' was actually doing. I think that regulators monitoring the implementation of the Volcker Rule ban on speculation should arm themselves with a variety of methodologies, including the analysis outlined in ‘Do Speculators Leave Footprints?' They should establish the same type of multi-dimensional approach that the IRS uses to identify tax evasion, including face-to-face audits where that is indicated.”