Wells Fargo is the latest bank to ramp up new forms of risky trading in advance of the Volcker Rule, a regulation included in the 2010 Dodd-Frank Wall Street Reform Act meant to make banks safer by prohibiting certain types of trades that helped trigger the global financial crisis in 2009. The rule bans proprietary trading, in which banks bet their own money for the sole purpose of turning large profits, at financial institutions that have the backing of taxpayers.
While some banks have done away with such trading, Wells Fargo is increasing it by relying solely on its own funds to invest in private equity markets, a practice known as “merchant banking” that will likely be allowed by the finalized Volcker Rule. That sort of banking, however, may turn out to be even more dangerous than the prop trading the Volcker Rule prohibits, Reuters reports:
Their decisions may run counter to rulemakers’ efforts to make the financial system safer. The merchant banking that Wells Fargo is embracing is riskier than investing in private equity funds with outside investors, where a bank shares any losses with others. Some critics warn that the Volcker Rule is banning the safer of the two activities, and allowing the one that could lead to bigger losses for a bank.
Some argue that banks should be blocked from any form of private equity investing. Sheila Bair, the former chairman of the Federal Deposit Insurance Corp, which guarantees the deposits of banks like Wells Fargo, said private equity and merchant banking are too far removed from regular banking.
“Is that really what you want institutions that have safety net support doing? Is that an appropriate use for a government backstop?” she told Reuters.
Wells Fargo’s quest for profits even through risky means is yet another indication that many Wall Street banks, undeterred by the financial collapse, are seeking any loophole they can find to continue raking in huge profits regardless of the potential cost. In January, Bloomberg reported that Goldman Sachs had set up a secret hedge fund-like entity meant to skirt the Volcker Rule, and banks have been fighting to weaken the rule since before Dodd-Frank became law. Those efforts have continued since, even in the face of the stunning JP Morgan Chase trading loss that prompted Senate Democrats to call for the closure of massive loophole that exists in the draft version of the rule.
Former bank executives, however, have made the case that a strong Volcker Rule is “necessary to correct a mistake that poses a major risk to our economy.” And while a forceful Volcker Rule would indeed make large banks less profitable, it would do so in a way that would also ensure that they pose less of a risk to the health of the American economy.