Implementing the Volcker Rule via the FDIC

There has been much commentary (see this as a smart example) on the scathing Senate hearings on JPM and the London Whale last week.

I wanted to take a moment to throw out a few ideas that relate to JPM’s embarrassing moment int he spotlight (again).

The TBTF giant banks want to eat their cakes and have it, too. These publicly traded companies want to maximize the returns on their invested, leveraged mostly off balance sheet dollars. They still are incentivized for maximum transfer of wealth form shareholders to insiders. They want FDIC insurance so the depositors are comfortable. They do not want to suffer their own losses, preferring to lay them off on third parties (GSEs, taxpayers, etc.) where ever possible. They want low cost FOMC monies to do this with, and full tax payer support for when they inevitably crash and burn.

It is the worst of 3 worlds: Socialism for the banks, crony capitalism for the insiders, with taxpayers on the hook for the downside.

The Volcker rule was aimed at separating the gambling with other people’s money (OPM) from the guaranteed deposits side of banking. Originally oart of the Dodd–Frank Wall Street Reform and Consumer Protection Act, the banks have managed to thwart its full implementation via lobbying and political influence.

We all understand why: The large investment banks are no longer partnerships, so their incentives remain maximizing returns, embracing enormous risk to do so. The upside is huge, while the downside risks — some reputational damage, but no financial risk or jail time — are de minimis.

Hence, why Volcker and others want to separate the low risk depository institutions from the much more speculative and risky iBanks. But until the Volcker Rule is capable of protecting taxpayers, there are alternatives. To remove the taxpayer from being the ultimate guarantor of all banker speculation, I suggest the FDIC step in.

The FDIC should add conditional elements to its depository insurance. The price increases for the the cost of deposit guarantees could be tied to various conditions. As these increase head the wrong way, increasing risk, the costs t the banks should scale up:

– Bank size
– Specific percentage of off balance sheet transactions (for many large banks, this is now over 50%!)
– Leverage ratios
– Capital reserves

None of this works if the accounting firms facilitate banks misrepresenting their balance sheets. We must make it clear that helping bankers make criminality appear legitimate is an irresponsibility that won’t be tolerated. Thus, the FDIC should maintain a list of accounting firms that meet its standards, with the penalty for accountants that violate the standards above being they get tossed off the list. You don’t need to Arthur Anderson them, just remove a huge source of their revenues for being complicit in fraud in order to get some cooperation from them.

One last thing: Any bank that ever gets bailed out again should be subject to a mandatory 10 year tax. I figure 3% of gross revenues or 15% of profits, which ever is higher, as a mandatory cost of bailouts will be a disincentive for the banks to engage in further recklessness.

As Josh Rosner detailed in these pages before the hearings, JPM’s controls and risk management are laughable. Their fortress balance sheet is illusory. Despite his reputation as the smartest banker of his generation, Jamie Dimon is one banana peel away from being Dick Fuld.



FDIC Rule Change Ends Too Big to Fail (May 24th, 2012)

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