The risky “London Whale” trading loss JP Morgan Chase reported last May was the result of a risky proprietary trade that should be banned by the Volcker Rule, a bipartisan Senate report alleged Thursday. The Volcker Rule would ban most proprietary trading, which is done with a bank’s own money only to turn profit, at financial institutions that have taxpayer backing.

When he announced the loss, which now amounts to more than $6 billion, JP Morgan CEO Jamie Dimon said the trade was a “hedge” and not a prop trade. As such, Dimon said, a stronger Volcker Rule would not have prevented the bank from engaging in the trade. But that was not the case, both Republican and Democratic senators said in the report, as Bloomberg reports:

“JPMorgan’s chief investment office increased risk by mislabeling the synthetic portfolio as a risk-reducing hedge when it was really involved in proprietary trading,” said Senator John McCain of Arizona, the panel’s top Republican.

Sen. Carl Levin (D-MI), the Permanent Subcommittee on Investigations’ chairman and a co-author of the Volcker Rule, said the Senate would work to close a loophole in the rule that may allow “portfolio hedges” similar to what JP Morgan attempted. At the time of the loss, Levin said the rule had a loophole wide enough “a Mack truck could drive right through it.”

Many of the loopholes in the rule, which is not yet finalized, may have resulted from JP Morgan’s lobbying. Dimon has been a vocal opponent of the rule, broadly considered the most contentious piece of the Dodd-Frank Wall Street Reform Act, and JP Morgan and other banks lobbied against it both before and after Dodd-Frank passed. A host of former bankers have announced support for the rule and said it was necessary for financial stability, but the rule was watered down significantly, so much so that its namesake, former Federal Reserve chairman Paul Volcker, said he was no longer satisfied with it.

The committee will hold a hearing on the trading loss today. The JP Morgan official who ran the unit that oversaw the massive loss is scheduled to testify.

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.

Goldman Sachs chief executive Lloyd Blankfein has said repeatedly that his bank would comply with the Volcker Rule, a new regulation from the Dodd-Frank Wall Street Reform Act meant to eliminate the most risky trades from banks that have the backing of the federal government and its taxpayers. Despite those promises, the bank has set up a secret fund that is still engaging in those trades, Bloomberg reports:

That may come as a surprise to people working in a secretive Goldman Sachs group called Multi-Strategy Investing, or MSI. It wagers about $1 billion of the New York-based firm’s own funds on the stocks and bonds of companies, including a mortgage servicer and a cement producer, according to interviews with more than 20 people who worked for and with the group, some as recently as last year. The unit, headed by two 1999 Princeton University classmates, has no clients, the people said.

Multiple sources Bloomberg cited referred to MSI as a “hedge fund,” the type of entity to which the Volcker Rule was meant to steer risky proprietary trading. But those funds, under the intent of the rule, were supposed to be independent from banks that have taxpayer backing. Goldman Sachs, an investment bank until the 2008 financial crisis, was classified as a bank holding company that year to give it access to the Federal Reserve’s emergency lending programs and federal government backing. Under the Volcker Rule, banks must give up such access, and the taxpayer backing that comes with it, to engage in prop trades.

Goldman’s insistence that MSI’s practices comply with the rule because they are long-term in nature is, however, another indication of the way banks can work the weakened rule in their favor. Wall Street lobbyists, with the help of Republican senators, watered down the rule before its passage and have sought to weaken it even further before it is fully implemented. The result was a rule with loopholes “big enough…that a Mack truck could drive right through it,” one that was so weak its namesake, former Fed Chairman Paul Volcker, was dissatisfied with it. Multiple former bank CEOs, however, have called on regulators to make the rule as strong as possible because it is “necessary to correct a mistake that poses a major risk to our economy.”

Republicans, with help from Wall Street’s biggest banks, have already successfully watered down one of the most important financial regulations included in the 2010 Dodd-Frank Wall Street Reform Act. Now, two House Republicans are attempting to delay the rule’s implementation for another two years, even though it is already behind schedule and likely won’t be finished until 2013.

The regulation in question is the Volcker Rule, which would prohibit certain kinds of risky trades — known as proprietary trades — at banks that are backed by taxpayers and the federal government. Prop trading is widely credited with playing a role in the collapse of the financial industry in 2008, and the Volcker Rule, named for former Federal Reserve chairman Paul Volcker, is aimed at preventing a similar occurrence in the future. Reps. Spencer Bachus (R-AL) and Jeb Hensarling (R-TX), though, are attempting to ensure it won’t take effect for another two years, Bloomberg reports:

“Given the time that it will take for you to agree on one version of the Volcker Rule as well as the tremendous uncertainty that market participants face in trying to anticipate what the final rule will look like, we respectfully suggest that the Federal Reserve Board delay the Volcker Rule’s effective date,” the lawmakers wrote. [...]

“While the Volcker Rule promises little if any benefit, what little benefit it does promise will not be realized if regulators further fragment financial markets and ratchet up the costs of compliance for market participants by issuing multiple versions of the Volcker Rule,” the lawmakers wrote.

Republicans and Wall Street banks lobbied to prevent the Volcker Rule’s inclusion in Dodd-Frank, and though they were ultimately unsuccessful, outgoing Sen. Scott Brown (R-MA) made sure it was watered down before the bill passed. Both the GOP and Wall Street have fought the rule incessantly since its passage, lobbying regulators and Congress to water it down even further. It’s so weak now — it includes a loophole large enough to drive a Mack truck through, according to one of its original authors — that Volcker himself isn’t satisfied with it.

And contra Bachus and Hensarling’s claims, the Volcker Rule provides a major benefit to taxpayers. It will indeed make banks less profitable, but it also makes them safer by shifting risky trading to hedge funds and other institutions that aren’t backed by taxpayers, thus ensuring that risky trading won’t again jeopardize the entire financial system and billions of taxpayer dollars. Despite opposition from the GOP and current bankers, it is backed by former traders and ex-CEOs of major Wall Street banks, including the former Citigroup chair credited with inventing the type of supermarket banks the rule is designed to prevent. The rule, according to a former Merrill Lynch executive, is “necessary to correct a mistake that poses a danger to our economy.”

A new regulation meant to prohibit federally-insured banks from engaging in risky trading practices will cost the nation’s largest financial institutions more than twice as much as originally estimated, according to a new analysis by ratings agency Standard & Poor’s. But the rule would also make those banks less of a risk to the U.S. economy, S&P found.

The Volcker Rule, which will keep banks that are backed by taxpayers from engaging in the risky proprietary trading that played an outsized role in bringing down the financial market four years ago, will cost the nation’s eight largest banks up to $10 billion in annual profits, two-and-a-half times as much as S&P estimated in 2010:

“We currently estimate that the Volcker rule could reduce combined pretax earnings for the eight largest U.S. banks by up to $10 billion annually, up from our initial $4 billion estimate two years ago,” S&P said today in a statement announcing a new report on the issue.

Still, that will hardly put a dent in their collective profits. The eight banks — JP Morgan Chase, Morgan Stanley, Bank of America, Goldman Sachs, Wells Fargo, U.S. Bancorp, Citigroup, and PNC — earned more than $63 billion in combined profits in 2011 as Wall Street continued to rebound from the financial crisis. JP Morgan ($19 billion) and U.S. Bank ($4.9 billion) each posted record profits last year; Wells Fargo ($15.9 billion) and Citigroup ($11.3 billion) joined JP Morgan as the three banks to earn more than $10 billion in profits individually.

And, as S&P noted, less risky trading will lead to safer banks. “The implementation of the Volcker rule could have favorable implications for the credit profiles of some of the largest U.S. banks, such as reducing trading portfolio risk,” S&P said. “This risk mitigation could lessen revenue and earnings volatility, which we would view favorably.”

Wall Street has attempted to water down the Volcker Rule since its insertion into the Dodd-Frank Wall Street Reform Act in 2010. They were successful in lobbying for a loophole that allowed them to continue some risky trading practices, and since the law’s passage, the banks have attempted to make the rule even more tepid. Regulators are scheduled to finalize the proposed rule by the end of this year.

A new study from economists Arnoud Boot at the University of Amsterdam and Lev Ratnovski at the International Monetary Fund shows that banks trade too much, so new regulation is necessary to keep the world’s biggest banks from posing a risk to the entire global economy.

Boot and Ratnovski’s study found that excess capital generated from traditional banking activities allows banks to gamble on risky trading, and since the biggest banks have more capital, they gamble even more. This causes a diversion of capital toward trading that adds instability to financial markets.

And because banks will always engage in such trading, the best way to prevent it is through regulation like the Volcker Rule, a provision in the 2010 Dodd-Frank Wall Street Reform Act that would prevent banks from making risky trades with taxpayer backed dollars:

Our results highlight the dynamic problems in universal banking and sheds light on the desirability of restricting bank activities of the type that were recently proposed by the Volcker rule in the U.S. and the Vickers report in the UK.

Originally one of the strongest provisions contained in Dodd-Frank, the Volcker Rule was watered down by Republican senators and bank lobbyists so much its namesake Paul Volcker is no longer satisfied with it. But recent trading losses like the one sustained in JP Morgan Chase’s “London Whale” trade have caused the rule’s authors to urge regulators to strengthen it before it is fully implemented.

According to Boot and Ratnovski, banks that are allowed to engage in risky trading will always do so because it allows them to gain larger profits. Because of this, the supermarket banking model — in which banks both lend and act as investing houses — “is no longer sustainable.” That’s a view shared by many former bankers, including former Citigroup CEO Sandy Weill, who helped pioneer the expansion of banking institutions into trading and other services.

The Senate panel responsible for probing the $9 billion “London Whale” trading loss that shook JP Morgan Chase earlier this year will release its findings before the end of the year and will call for a stronger Volcker Rule, sources told Bloomberg. The rule is a piece of the 2010 Dodd-Frank financial reform law that bans taxpayer-backed banks from certain types of risky trades.

Michigan Sen. Carl Levin (D), who chairs the Senate Permanent Subcommittee on Investigations, said at the time of the loss that the draft version of the Volcker Rule had a loophole so large “a Mack truck could drive right through it.” Now, according to Bloomberg, he and Sen. Jeff Merkley (D-OR) will push regulators to close loopholes in the rule and strengthen it to prevent trades like the London Whale loss, which could have caused larger market problems at smaller or more vulnerable banks.

At the same time, some Republican senators are still pushing to further weaken the rule, which was watered down so much by bank lobbyists and Republicans that its namesake, former Federal Reserve Chair Paul Volcker, said he didn’t like it.

Massachusetts Sen. Scott Brown (R) cast the deciding vote for the Dodd-Frank law, but not before he successfully weakened the Volcker Rule by inserting certain exemptions for big banks. Since then, Brown has continued to lobby regulators to take even more teeth out of the rule. Brown’s efforts amount to “significant loosening of the regulations and [are] absolutely serving the interests of people who do not want to have meaningful reform,” according to Simon Johnson, and MIT professor and reform advocate.

Former Citigroup Chairman and CEO Sanford “Sandy” Weill called for the separation of deposit and investment banks in an interview this morning on CNBC’s “The Squawk Box.” Weill is credited with inventing the so-called financial supermarket, a type of financial institution wherein a wide range of products involving banking, real estate, and stock trading are all available.

While the financial supermarkets were “right for their time,” Weill said, times have changed and it is time to break up the banks to protect taxpayers and financial institutions:

WEILL: What we should probably do is go and split up investment banking from banking, have banks be deposit takers, have banks make commercial loans and real estate loans, have banks do something that’s not going to risk the taxpayer dollars, that’s not too big to fail. If they want to hedge what they’re doing with their investments, let them do it in a way that’s going to be market-to-market so they’re never going to be hit.

Watch it:

Later, Weill went even farther, explicitly saying the banks needed to be broken up. “I’m suggesting that they be broken up so that the taxpayer will never be at risk, the depositors won’t be at risk, the leverage of the banks will be something reasonable, and the investment banks can do trading, they’re not subject to a Volcker Rule, they can make some mistakes, but they’ll have everything that clears with each other every single night so they can be market-to-market,” Weill said.

Weill isn’t alone in his endorsement of separating commercial banking from riskier investment banking. A former Goldman Sachs trader made the case for it in his resignation letter and another former Citigroup CEO, John Reed, wrote a letter to the Securities and Exchange Commission calling for breaking up the biggest banks.

JPMorgan Chase CEO Jamie Dimon announced on a conference call yesterday that the bank suffered $2 billion in losses from a risky trade that turned sour. The trade dents Dimon’s case that Wall Street can responsibly manage itself and yet again proves the need for a strong Volcker Rule, which could largely ban such risky trades at federally-insured institutions.

“There were many errors, sloppiness and bad judgment,” Dimon said as the company’s stock fell in extended trading. “These were egregious mistakes, they were self-inflicted.” Those errors, however, could have been prevented were it not for extensive lobbying efforts from banks like JPMorgan, which has spent nearly $10 million on lobbying since the beginning of 2011 (including nearly $2 million already this year). Dimon, in fact, was in Washington just last week to personally lobby the Federal Reserve to weaken the Volcker Rule.

Those lobbying efforts have worked. Dimon insists that the trade-gone-wrong was a hedge, not a proprietary bet, and as such would not be banned under Volcker. The only reason that’s true, however, is because Dimon is referring to the trade as a “hedge” to exploit a loophole Wall Street banks and their Republican allies helped insert into the watered-down version of the Volcker Rule that was included in the Dodd-Frank Wall Street Reform Act. That’s a loophole Sens. Carl Levin (D-MI) and Jeff Merkley (D-OR) have been trying — unsuccessfully — to close, as Bloomberg notes:

Levin and Merkley, in their February comment letter, pushed regulators to tighten the exemption for hedging, calling some of what may be allowed a “major weakness” in the rule.

Dimon acknowledged that the losses would lead to scrutiny and calls for a tougher Volcker Rule yesterday, saying the blunder “plays right into the hands of a bunch of pundits out there.” What Dimon ignores, though, is that yesterday’s massive loss — big even by JPMorgan’s lofty standards — does in fact exemplify the need for such a rule. For years, banks have made billions in profits from risky bets like this one, but when too many of the deals went bad in 2008, they turned to taxpayers for a bailout.

Thursday’s events prove that Wall Street hasn’t learned its lesson from the last crisis, and that America’s “too big to fail” institutions are too irresponsible to avoid failure. The Volcker Rule, watered down as it may be, is aimed at preventing that. Unfortunately, Dimon and his Wall Street colleagues remain committed to making sure it won’t.

MOUNT PLEASANT, Wisconsin — Rep. Paul Ryan (R-WI) made a surprising policy assertion late last week, seemingly telling a Wisconsin town hall that he supports a key financial regulation pushed by President Obama and progressives in Congress.

“If you’re a bank and you want to operate like some non-bank entity like a hedge fund, then don’t be a bank,” Ryan told constituents on Friday. “Don’t let banks use their customers money to do anything other than traditional banking”:

RYAN: I think we should have the same rules apply to everybody else. We should make sure you can’t get too big where you’re going to become too big to fail and trigger a bailout, and if you take risky behavior then you go into bankruptcy and we open up the bankruptcy laws to allow them to go into bankruptcy. And more importantly if you’re a bank and you want to operate like some non-bank entity like a hedge fund, then don’t be a bank. Don’t let banks use their customers money to do anything other than traditional banking. Those to me are the key tenets of reform which we did not see happen.

Watch it:

A proposal doing almost exactly that — known as the Volcker Rule, after former Federal Reserve Chairman Paul Volcker — was part of the Dodd-Frank financial reform law and has been opposed by most Republicans in Congress. The Volcker Rule largely bans banks that are backed by taxpayers from engaging in risky proprietary trading, limiting such activity to hedge funds and institutions that are not federally insured. With the Volcker Rule in effect, banks would either give up the sort of trading that played a major role in the financial crisis or forfeit their access to the Federal Reserve’s emergency lending and the FDIC’s backing.

While Ryan talks like someone who wants to rein in Wall Street at town hall meetings, it isn’t always the game he plays in Washington. Ryan opposed Dodd-Frank, and his biggest backer is the financial industry, which has had so much success lobbying to water down the rule that not even Volcker himself is satisfied with it anymore.