Tuesday, May 04, 2010

Just What Is "Proprietary Trading" Anyway?

Much has been made recently of the belief that "proprietary trading" did not actually cause the demise of Bear Stearns or Lehman Brothers, and, thus, is of no consequence in the evolving FINREG bill.

I believe this is wrong. It takes too narrow a view of just what proprietary trading actually entails.

To me, proprietary trading may technically define or describe only those as-principal activities on an investment or commercial bank's trading desks which risk the firm's own capital.

However, the broader notion meant by people like Paul Volcker, in articulating his Volcker Rule is, I believe, that of the risking of a bank's capital on any underwriting, long term investments or high-frequency trading for its own account.

The key common element isn't the duration, which could rule out proprietary trading as the culprit of some now-defunct banks' woes, but, rather, the risking of the bank's own capital in market-valued instruments and activities.

When banks which do this are also in the business of taking insured deposits, then they are implicitly being backed by the FDIC and, ultimately, taxpayers.

Lehman was brought low, in part, by the poor quality of the commercial mortgage assets it chose to hold on its books. That was proprietary investment.

Bear Stearns was believed, by its commercial bank lenders, to have asset quality problems which made those overnight loans too risky.

Were the assets the result of trading, or underwriting, or investment? Doesn't really matter.

They were owned by the firm, and lost more value than there was equity to back them.

Trading...investment.....really, what's in a word, in this case? The time dimension isn't what is important when considering the reform of financial regulations and structure regarding a bank's risk exposure while also taking insured deposits.

The source of the risk capital is.

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