By Pam Martens: February 16, 2012
Occupy the SEC, an affiliated group to Occupy Wall Street, has filed a 325 page comment letter on the SEC’s proposal for implementing rules pertaining to Wall Street’s practice of trading billions of dollars for the accounts of the firm (proprietary trading) rather than limiting their trading to benefit their customers. The rule is called the Volcker Rule, after its namesake, former Federal Reserve Chairman Paul Volcker.
The SEC and Wall Street want to carve out market making from the prohibitions against proprietary trading. Here’s an excerpt from Occupy the SEC’s letter that has to be causing a lot of indigestion on Wall Street this week.
Market making is an indispensable component of liquid, efficient markets. This service, however, simply does not belong in banks. One of the most challenging aspects of our attempt to digest and comment on this Proposed Rule has been navigating the presupposition that banks have some inherent role in proper market making. We are familiar with the extensive lobbying efforts by the banking industry to present this idea as a fact, but we propose that the Agencies seriously reconsider this premise for both the safety and soundness of the industry and the simplicity of this Rule. Nobel Prize winner Myron S. Scholes wrote:
[A] leveraged market-making business is inherently unstable. Banks might be the wrong providers of liquidity to markets. Simply put, leverage can only be reduced by selling assets to raise cash if market makers are making markets in the assets they need to sell and they no longer can continue to do so at times of shock and to make conditions worse, they borrow from each other with short-term financing to hold longer-maturity relatively idiosyncratic assets.45
The bank lobbying effort is certainly understandable: market making is a profitable business and one that banking entities certainly do not want to lose. It is well-known that the major dealers have always fiercely guarded their dominance of market making, particularly in the less regulated OTC markets. Firms that attempt to enter this business are regularly strong-armed through anti-competitive arrangements with inter-broker dealers.46 Again, this is unsurprising: market making desks allow a firm to take proprietary advantage of unparalleled access to valuable customer flow information in the name of “customer service.”47 This is an extremely attractive business. Despite the banks’ desire to continue reaping such profits, their contention— that banking entities alone are able and willing to provide this valuable service to the market, and that regulation will cause irreparable damage to the financial system at large—is unfounded and nonsensical.
45 Myron S. Scholes, Market-Based Mechanisms to Reduce Systemic Risk, in The Road Ahead for the Fed 103, 108 (John D. Ciorciari & John B. Taylor eds., 2009).
46 See Intervest v. Bloomberg, 340 F.3d 144, 2003 U.S. App. LEXIS 16423, at *26 (3d. Cir. 2003) (“According to his ACT Notes, Fondren met again with Matthews and Tom Evans, another Cowen executive, on May 29, 1997. Fondren recorded that Evans initiated the meeting to inquire whether InterVest might assist Cowen in developing its own bond trading exchange over the internet. Matthews, however, seemed less interested in dealing with InterVest and told Fondren that doing business with InterVest was ‘viewed by the street as “unhealthy.”’ When Fondren responded by charging that locking InterVest out of the bond market was anti-competitive and could lead to a lawsuit, Matthews allegedly laughed and said that even if Cowen was forced to pay $10 or $20 million, ‘it would be just a cost of doing business.’”).
47 156 Cong. Rec. S5896 (daily ed. July 15, 2010) (statement of Sen. Merkley) (“Market making is a customer service whereby a firm assists its customers by providing two-sided markets for speedy acquisition or disposition of certain financial instruments. Done properly, it is not a speculative enterprise, and revenues for the firm should largely arise from the provision of credit provided, and not from the capital gain earned on the change in the price of instruments held in the firm’s accounts.”).