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Mr. President, Are SIVs Considered Prop Trading?

Posted by Larry Doyle on January 22, 2010 8:09 AM |

Is President Obama’s proposal to rein in risk on Wall Street genuine or merely another Washington political ploy to curry favor with an enraged American electorate?

As with any proposal, the devil is always in the details. Initial pushback from Wall Street is strong but also informative. What is Wall Street highlighting? The large Wall Street banks are promoting the fact that proprietary trading operations do not encompass a large percentage of their overall business. In fact, JP Morgan already shut down an internal proprietary trading business in 2009.

I believe Wall Street will paint Obama’s proposal as an overreaching and aggressive intrusion into its business and free enterprise. What are we to make of all this? What exactly is Obama proposing? I’m not sure even he would know. The fact is, Obama’s proposal to curtail proprietary trading resides in defining exactly what proprietary trading encompasses.

At first blush, I witness the use of the following terms:

1. internal hedge funds

2. private equity operations

3. principal trading

If those three activities are broadly utilized to define proprietary trading, then we might as well shut Goldman Sachs down right now. That is obviously not going to happen.

I do think there are real merits to curtailing risk within these bank business units. That said, were these aforementioned business units the core of the risk on Wall Street that ultimately crushed Main Street? No, they were not.

Wall Street’s risk that crushed Main Street was centered in the structured investment vehicles (SIVs) housed off-balance sheet. Well, then America should certainly expect that these SIVs will be shut down or immediately brought onto the balance sheet and capitalized appropriately, correct? Not so fast.

The Wall Street lobby has been hard at work fighting the SIV battle and has won the initial fight.  How so? Regular Sense on Cents readers may recall that I addressed the SIV battle in writing, “12th Street Capital Reviews FASB 166 and 167 and Tells Us Why Wall Street Will Need More Capital”:

In brief, FASB 166 and 167 will require hundreds of billions in assets to be moved from off-balance sheet vehicles onto the balance sheets of the financial institutions. As those assets, which are embedded in an array of securitization transactions, come on balance sheet, the banks and non-banks alike will have to raise more capital to support the growth in their balance sheets. Best guesstimate is that the institutions will need to raise capital in the tens of billions.

Are the financial institutions taking this rule change sitting down? No, but the FASB’s comment period is over and the implementation of FASB 166 and 167 is upon us as mentioned previously.

Is this accounting rule the reason why certain institutions are hoarding cash? Likely. That said, rest assured the financial lobby is fighting to have the FASB forestall and actually fully reconsider the implementation of 166 and 167.

The Wall Street lobby won a stay of execution on this front. I highlighted as much in early December in writing, “UPDATE: FASB 166 and 167.”

As I conclude my writing this morning and monitor Bloomberg News, Chris Whalen (one of if not the most highly regarded bank analysts on Wall Street) of Institutional Risk Analytics is also pointing to the need to focus on the following:

1. SIVs

2. Full transparency within the derivatives space.

3. SEC registration of all structured securitizations.

Whalen handicaps the implementation of Obama’s proposal (known as the Volcker Plan) as very low.

I continue to maintain that if Obama is genuine in his desire to address risk on Wall Street, he needs to fire his financial generals charged with executing his plan. Unless and until that happens, I believe Obama’s stumping yesterday was nothing more than mere political pandering in an attempt to steal the attention from the historic results in the Massachusetts Senate race.


Related Sense on Cents Commentary

If Wall Street Wants a Fight, Obama Should…; (January 21, 2010)

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