Why Financial Reform Hasn’t Stopped Rogue Traders

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A part of the Dodd-Frank bank reform bill named after former Fed chairman Paul Volcker was supposed to halt rogue traders. It is delayed. (Brian Snyder / Reuters)

After the financial crisis, regulators and politicians said they were going to rewrite the rules to ensure that big banks don’t end up with huge losses that put a country’s and indeed the world’s financial system at risk. Allowing the big banks to make big bets was out. And yet, here we go again. On Friday, U.K. authorities charged Kweku Adoboli with three counts of accounting and financial fraud. He was arrested on Thursday morning, a few hours before Adoboli’s employer UBS revealed to the world what it had learned just a day before – that a rogue trader had cost the Swiss bank $2 billion in losses.

The good news perhaps is that the huge loss – which equals more than 10% of the economy of Ghana, which is where Adoboli’s family is from – is at a Swiss bank. The Swiss economy is relatively strong right now, and its currency, until recently, has been one of the few to continue to appreciate despite the world economic slowdown and European debt crisis. If it had been say Soceite Generale or some other French bank or perhaps a Greece bank that had told the world that it was facing a $2 billion trading loss, world stock markets would not have been up yesterday, or again today. They would have been down big. And we might very well have been on our way to the next full-blown financial crisis.

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Financial reform was supposed to protect the banks, and more importantly the rest of us, from the downsides of risky trades. But it hasn’t. Clearly, not in Switzerland or the U.K., which is where Adoboli was located, and not in the U.S. Here’s why:

The Dodd-Frank financial reform bill, which was passed by Congress last summer, does contain a provision – called the Volcker rule – that is supposed to limit the size of risky trades a bank can make. But the problem is the rule has yet to be enacted, and it probably won’t be for a while, if ever. Earlier this week, the Wall Street Journal reported that, more than a year after Dodd-Frank passed, regulators had yet to finalize even a draft of the final Volcker rule.

The problem is the banks are still fighting the rule. Last December, Wall Street industry and lobbying group the Securities Industry and Financial Markets Association released a study that concluded that the Volcker rule would both make it more expensive for corporations to borrow and lead to lower returns for investors in the market. It goes without saying, but I will anyway, that another financial crisis would do the same.

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Of course, it’s probably unlikely that we would have a UBS-like loss right now at one of the big U.S. banks. In preparation for the Volcker rule, a number of banks have closed their proprietary trading desks, or significantly reigned in traders. Yesterday, Goldman Sachs said it was closing what was once one of its largest hedge funds. What’s more, it would probably take a lot more than a $2 billion loss to topple a major U.S. bank. Bank of America, which has been having problems recently, for example, has over $70 billion in capital to cover potential losses like these. But banks have to hold more capital on their books these days in order to protect themselves from events like this, which mean less capital toward lending.

Still, as in other reform battles, banks are likely to win back some ground. That probably means the Volcker rule won’t go quite far enough to ban risky trades on Wall Street. And that would be a shame. The Volcker rule was a good idea when it was proposed. And the $2 billion loss at UBS shows again how badly we need it.