Fight over Proprietary Trading Looms
One likely area of contention is placing a barrier between proprietary trading – investments banks make on their own behalf with their own capital – and day-to-day customer transactions. Mr. Obama dubbed this the "Volcker Rule," after Paul Volcker, a former Federal Reserve chairman and one of the president's top economic advisers. (Seen with President Obama at left.)
While many proprietary traders are removed from commercial transactions, there are more muddled areas that could present banks and/or regulators with a dilemmas, according to a Wall Street Journal report ($) Tuesday.
One such instance is the case of market makers – traders that use bank capital to buy and sell securities to customers who are either in a hurry or lack a ready counterparty, according to the Journal. But they also execute proprietary trades to offset the risk of the customer transactions.
The Journal's Kate Kelly provides this example:
"As a market maker, a bank buys from a customer $25 million of 10-year bonds issued by government-sponsored mortgage company Fannie Mae. To offset the risk of those bonds falling in value if interest rates rose, the bank might then sell $25 million of 10-year Treasurys. That sale could be considered a proprietary trade."
Banks aren't excited about the government restricting their ability to use their own capital to hedge against customer trades, arguing that it would cripple the market's liquidity. But some analysts think the effect of tighter regulations wouldn't have nearly as dire consequences as banks indicate, according to the report.
Administration officials are working on ways to clarify the new rules.
"On the substance of proprietary trading, there are complicated issues here," Neal Wolin, deputy Treasury secretary, told the Journal. "In the coming weeks, we will propose legislative language. …We have obviously listened to a full range of people who have insights that could be brought to bear."
Both Volcker and Wolin are set to testify before the Senate Banking Committee Tuesday.