Public Statements & Remarks

Symbols, Cymbals and Systems - A Culture Shift Conversation

Keynote Address of Commissioner Bart Chilton to the Hard Assets Investment Conference, Chicago, IL

September 21, 2012


Thank you for that generous introduction and for the invitation to speak with you today in Chicago. I’m excited to be here.

I’m also pleased to not talk too much about a bunch of rules and regulations today—although there will be some. Instead, let’s do something a little different and talk, overall, about what is going on in our financial system.


First, let’s talk about symbols, with the “sym.” And I’d like to use a visual aid here, so everyone pull out a one dollar bill, if you have one. If not, share with your neighbors. We’ll do the buddy system for some of you.

What you are looking at is probably the most identifiable paper money in the world—our U.S. Federal Reserve note. It isn’t just currency: it is highly symbolic.

You see on the front there to the left is the Federal Reserve seal and within it is a letter which corresponds to one of the 12 Federal Reserve Banks—where the bill was originally circulated. The numbers that you see in four places correspond with each bank as well. Now look to the right. There is the U.S. Treasury seal with the scale symbolizing balance and justice. Below is a key symbolizing authority. There is also a chevron with 13 stars. As those who saw the movie National Treasure with Nicolas Cage know, the 13 stars signify a bakers’ dozen and the dual importance to our nation of one, baking, and two, making bread—or at least dough. Oh, wait, that’s not it. Thirteen is obviously symbolizing the original colonies and we will see it several more times on our tour around the dollar bill.

Let’s look at the other side for more symbolism. The Founding Fathers really knew just how critical symbols were when they were deciding what our nation’s seal would look like. So prior to the Continental Congress adjourning on July 4th, 1776, they set up a committee—like governments do—to create a seal for our country. This seal, eventually (you can see there), ended up on our money.

The committee included John Adams, Thomas Jefferson and Benjamin Franklin. What a group! If Jefferson and Franklin had their druthers, we’d have a turkey and not an eagle on our seal, by the way. You can see the eagle there, rising and flying freely—“Free Bird.” “And this bird you cannot change. Lord knows, we can’t change.” Sorry. By the way, the phrase, “In God We Trust” wasn’t added until 1957, although it was used on some coins before that.

That first committee work took six years (see, government was slow from the get-go). The final proposal for the seal was presented and approved by Congress, and what you see on the back of your dollar bill is almost exactly it.

The pyramid and the eagle, in tandem comprise the Great Seal of the United States. There are two Latin phrases inside this circle there. On top, Annuit Coeptis, which means, according to some translations, “Providence has favored our undertakings.” The one below, Novus Ordo Seclorum means a new order for the ages.

The pyramid has 13 rows of building blocks. We know what the 13 rows represent. While it is difficult to see, the first row has some Roman numerals. They spell out “1776,” a rather auspicious date for us. And of course, there is the unfinished pyramid block with the all-seeing eye atop.

In the eagle’s beak there is a banner which reads "E Pluribus Unum": “Out of many, one." The shield on the eagle's breast is comprised of two main portions: a band across the top (which in color is actually blue) and signifies Congress, and below the band there are 13 vertical stripes (in color, these are obviously red and white). The 13 stars above the eagle signify a new constellation emerging in the universe, similar to how our new nation was taking place among others.

Finally, you see the eagle holding 13 arrows in one talon. In the other is an olive branch—signifying peace. Well, the symbolism of our seal was so significant that the 13 arrows, at one time on silver coins, appeared in the right talon and some nations’ leaders and journalists suggested that meant an aggressive or belligerent attitude. As you can see here, the arrows are in the left talon and the olive branch is in the right talon. I’m not sure why right-handed eagles were thought to be so offensive. After all, Michael Vick is a left-handed Eagle and he is certainly offensive—I mean, an offensive player.

Since the inception of our nation, symbols—like those on our money—have had serious significance. They still do today.

Banks and the U.S.—the System

It’s not just our currency; however, that holds profound symbolism. So do our banking institutions. There is a reason that banks are often imposing structures: big, impressive foyers, marble columns, and brass scrollwork. These physical surroundings are symbolic and emblematic: they represent solidity, security, soundness. These impressive structures are intended to convey to us that our money is safe and secure, and that the foundations of our economy are sturdy, robust, and enduring. If you think about our great country and the financial system that helps fuel it, you simply can’t underestimate the importance of our banking institutions.

We recognize that banks are for-profit organizations that endeavor to use depositors’ funds as backing for investments. They accumulate deposits from customers, and those funds can be used for investments and capital formation. At least, that has been the historical role. Banks are a critical component—big time—in building our nation in minor and major ways. We wouldn’t have railroads, or the fantastic road system we have, without them. We wouldn’t have the municipal and community buildings in our cities and towns. People wouldn’t have homes. We wouldn’t have the businesses we have or the jobs that were created without the banks. Good, bad or ugly, banks are part and parcel to our modern financial system.

Our society wouldn’t be much, if anything, without banks. Yay for banks! Yay for bankers! “It’s a Wonderful Life.” Mr. Potter for president! Well, maybe not that last one. But, banks are fundamental to our nation. They help fuel the economic engine of our democracy and they have serious symbolic significance. In fact, two banks—Bank of America and U.S. Bank—have our nation’s name right in them. Our nation and banks, to some extent, are inextricably linked.

Unfortunately, the symbolism of banks—safety, solidity, security—has been tarnished in recent years. In candor, most of us realize that there are some not-too-pleasant and all-too-real reasons for that.

Worthy of Trust?

Most of us can’t even keep track of all the transgressions going on in our financial sector. We saw both Goldman Sachs and Citi establish these fake-out funds (Goldman called it Abacus and Citi called it their Class V Funding III Securities), where they pressed their customers to participate, then once the fake-out funds were populated with their own customers, the banks themselves took the opposite positions. Goldman paid $550 million in a settlement with the Securities and Exchange Commission (SEC), and Citi’s $285 million SEC settlement was tossed out by a judge as too lenient.

You remember the name Greg Smith? He was Goldman’s Executive Director and head of the firm’s U.S. equity derivatives business in Europe, the Middle East and Africa. After 12 years with Goldman, he resigned, penning a letter that appeared in the New York Times in which he said he’d worked at the bank “. . . long enough to understand the trajectory of its culture, its people and its identity. And I can honestly say that the environment now is as toxic and destructive as I have ever seen it.” Smith went on to say:

    “To put the problem in the simplest terms, the interests of the client continue to be sidelined in the way the firm operates and thinks about making money [. . . .] It might sound surprising to a skeptical public, but culture was always a vital part of Goldman Sachs’s success. It revolved around teamwork, integrity, a spirit of humility, and always doing right by our clients. The culture was the secret sauce that made this place great and allowed us to earn our clients’ trust for 143 years. It wasn’t just about making money; this alone will only sustain a firm for so long. It had something to do with pride and belief in the organization. I am sad to say that I look around today and see virtually no trace of the culture that made me love working for this firm for many years. I no longer have the pride, or the belief [. . .] I truly believe that this decline in the firm’s moral fiber represents the single most serious threat to its long-run survival.”

As far as I can tell, things are changing in a positive fashion at Goldman Sachs, and perhaps at other institutions. Things like this, however, don’t take place in the entire financial sector with a memorandum or a few pep talks. They take time, perseverance and a real cultural shift, in my view.

And it is by no means just those two banks that have experienced problematic issues. Wells Fargo—the largest home mortgage bank in the country—entered into a $175 million settlement with the Department of Justice (DoJ)—the second-largest residential fair lending settlement ever. That case involved brokers that charged higher fees and rates to more than 30,000 minority borrowers. From 2004-2009, Wells Fargo charged more to minorities than they did for white customers with the same credit ratings. Tom Perez, DoJ’s Assistant Attorney General for Civil Rights, said it amounted to a “racial surtax.”

Then there is Barclays—one of the largest banks in the world—and its attempted manipulation of Libor rates. As you know, Libor rates affect just about everything in the world involving credit extensions. They are at the foundation of our global economic system, and Barclays tried to rig the numbers. They settled with us for $200 million. They also settled with DoJ and with the U.K.’s Financial Services Authority (FSA).

And of course, there’s MF Global, in which hundreds of millions in customer funds went missing. In another case, The Peregrine Financial Group appears to have engaged in a $200 million fraud.

Last November, Bank of America agreed to a $410 million settlement for charging excessive amounts on overdraft and debit card fees to 13.2 million customers. The bank computer system organized customer debit card and ATM transactions from high to low dollar amounts, as opposed to when the purchase was made. Consequently, customers would enter into negative balance circumstances quicker. As a result, they’d bounce more times and the banks would receive more overdraft fees.

That’s appalling, yeah? Was that just a one-off? Nah, not hardly. In fact, about 13 banks—13 banks, (and they don’t symbolize the colonies for goodness sakes) agreed to enter into settlements for doing comparable things. The banks include JP Morgan Chase and Wells Fargo. The latest settlement, by the way, for those fee-fixing fiascos was in July, when U.S. Bank agreed to fork over $55 million to settle its lawsuits.

Oh, and in June, Merrill Lynch, which was purchased by Bank of America in 2009, was reported to have done the same thing from 2003 to 2011. They charged excessive fees to about 95,000 of their own customers, overbilling them $32.2 million. They were fined only $2.8 million. What a deal: overcharge $32.2 million and get fined $2.8 million.

All too often, it is clear that corporate executives crudely calculate fines as a cost of doing business. That’s gotta stop, and here’s how to do it. Regulators should full-on fine the firms and the foul folks involved to the maximum extent allowable under the law. Furthermore, criminal authorities, when they find an individual who does a crime, need to ensure they do the hard time—in prison. Do the crime, do the time, not just pay the fine.

That’s a lot of stuff, right? Whaddya call that? Some say malfeasance or corruption, or perhaps dishonesty, deceit or deception, maybe exploitation or sleaze, or maybe all of the above. Be honest here, when I go through that lengthy list—and there are many more examples, many more—don’t you feel uncomfortably numb to it? There are too many examples to actually grasp it all, aren’t there? What a shame that this has been occurring when the banks are so critically important to our nation, not to mention the symbolism it sends to the consumers about the culture of our financial system.

Some would criticize me and say that by pointing out these things, I’m doing a disservice to the industry that I’m overseeing. In fact, recently a banker related a concern that it is hard to send appropriate messages to consumers about what is going on with these banking lawsuits, “because the lawyers get involved.” My response was: Don’t be involved in bad behavior and the lawyers won’t be needed. And I have the same response to someone who criticizes me for pointing out all the myriad offenses going on in the financial sector: cut the crap and I’ll stop talking about it.

I’ll leave all that with this: a firm’s character and culture go together. It isn’t any wonder to me that many customers believe that these firms have proven unworthy of their trust. If it were just one or two, you could blow it off as idiosyncratic, but it isn’t; it is across a wide range of the entire financial sector.

Greg Smith’s letter laid it out pretty clearly for the industry when he wrote, “It astounds me how little senior management gets a basic truth: If clients don’t trust you they will eventually stop doing business with you. It doesn’t matter how smart you are.” That’s it, in a nutshell.

Rossini and Cymbals

Now, let’s discuss cymbals, with a “cym.” As the bankers say, “Stay with me, or you’ll lose interest.” Sorry, the problem with banker jokes is that the bankers don’t think they are amusing and most normal people don’t think they are jokes.

Last evening was the opening of the Chicago Symphony Orchestra’s season. Anyone attend? Ricardo Muti conducted three pieces, finishing with Ottorino Resphighi's Roman Festivals. Near the end, all the instruments are blazing and the cymbals clash. A more popular orchestral composition is Gioachini Rossini’s—the Italian Mozart’s—William Tell Overture, the theme from the Lone Ranger. At the age of 38 he'd written 38 operas, and then he stopped (although he may have written one more). If you like orchestra, you probably love hearing the William Tell. If you don't like orchestra, William Tell is still hard not to like. When the music really gets going—the stuff they used for the Lone Ranger—the cymbals, there too, are crashing, full tilt. That's especially true at the very end. It is amazing. So, the cymbals are used to alert us, to get us going, like the Lone Ranger's galloping horse, Silver. Hi-yo, Silver, away! But, it is the crashing sound—that loud, alerting sound—that I’m going to talk about just a bit.

After the 2008 economic crash (how smooth was that?), we should have all had a wake-up call—an alarm, an alert—we should have all heard that great crashing cymbal. After all, the economy was in the ditch, and as we all know, we still have a wheel there. We, all of us, had helped fund a $400-plus billion dollar bailout for some of the largest financial firms that exist. You might think that was enough to alert us all that something needed to be done. (Cue the William Tell Overture). Well, Congress passed regulatory reform: The Wall Street Reform and Consumer Protection Act, known as the Dodd-Frank Act. But even today, much to my amazement, we still have debate about if Dodd-Frank was even necessary. In fact, there are those who are continuing to try to repeal either all of the new law, or critical sections of the law that address specifically the problems that created the financial mess of 2008 (like the Volcker Rule, which we will get to a little later on).

I am often asked, why wasn’t anyone arrested for wrecking our economy? How come nobody is in jail? The answer is simple: what was done wasn’t against the law. Firms could offer silly-stringed mortgages; they could be immersed in off-the-grid trading, valuing things at whatever their hearts desired. Dodd-Frank changed that. So, repealing Dodd-Frank would return us to those thrilling days of yesteryear, right back to where we were. It could all happen again, but not now, nope, not with Dodd-Frank in place. If folks did what they did back then, and leading up to 2008, under Dodd-Frank, the government could go after firms and individuals and try to put them in the pokey—the crowbar hotel. So, when people talk about repealing Dodd-Frank, I think “my gosh,” seriously, all of it? You want to get rid of it all and go back to where we were?

Talk about the need for a crash cymbal to get our holy cow going! We need to reinvigorate ourselves and ensure that financial reforms aren’t reversed and we aren’t lulled into the pre-crash environment.

A Culture Shift Conversation

It isn’t just Dodd-Frank that can take care of our financial reform ills—the problematic symbolism—but more importantly that actual actions have been taking place. There is a change that needs to occur at the core of the financial system. That’s a hefty mandate, but one that I believe is absolutely necessary. Let me explain.

Like I said earlier, we are joined at the hip to some extent—the banks and our country—at least banking and our country. Therefore, today I am suggesting that we engage in a culture shift conversation, a shift in focus in our financial sectors, and both the government and the private sector need to be in on the discussion. After all, government can’t regulate business ethos or morality. All we can do is to incentivize good behavior and increase transparency. That should help breed confidence in our systems and our banking institutions. At the same time, the cultural mindset is something that needs to be addressed with the industry as a whole.

Frankly, I know there are some people who would, and probably will, say there is no need to have such a conversation about a culture shift in our financial sector. Some might, begrudgingly, accept that perhaps a few off-line discussions might take place, “But any conversations will be in the confines of the board room and we certainly don’t need any D.C. bureaucrat meddling with us. Who does he think he is—some kind of financial culture cop? Hey you! Get off of our cloud; don’t hang around ‘cause two’s a crowd on our cloud baby.” Others may say, “We were probably going to do it anyway. We have this retreat coming up,” or “We are already doing a bunch of things.” Well, good for them. Get your Nike on and “Just Do It.”

Excuse Me—Not a Lecture

And by the way, excuse me if I don’t want to accept potential promises for reform. Ya see, it hasn’t worked out so hot in recent years and some of us are a bit skeptical about what may or may not actually get done.

So, I’m gonna talk a bit about some unsolicited suggestions. I know, talk is cheap, unless you have one of those crappy calling plans. But sometimes, it is the best you can do. Look, if folks here don’t agree, if people who read this or hear me talk at other places about it don’t come to an understanding that this is a needed conversation, so be it. I’ll have done my part trying to get it going.

And just to be clear, I’m simply trying to start a conversation. This isn’t a lecture. An older man is stopped by the police about 2:00 a.m. and asked where he’s going so late in the evening. The man says, "I am on my way to a lecture about gambling, alcohol abuse and the effects it has on the human body, as well as smoking and staying out all hours." The skeptical officer then asks, "Really? And just who is giving that lecture and where is that lecture occurring at this time of night?" The man replies, "That would be my wife at my house."

So, I won’t be giving a lecture, but talking about how together, with government, the private sector and other interested parties, we might move forward on this cultural shift conversation. The effort is simply to improve our financial system and move away from what seems to be a Gordon Gekko-ish “greed is good” culture in which we appear to, on many occasions, be slithering into.

This conversation, of which I speak, or in Yoda-speak, “This is a conversation, seeking to have, am I,” isn’t just something for today or tomorrow or for next week. It will take some time and should take place in executive suites, board rooms, lunch rooms, hearing rooms, and perhaps even in court rooms. So, these are simply my opinions, ideas and questions—not a lecture or sermon here. After all, I’m from the government and I’m here to help.

Remedies: Compensation Systems

So, what’s to be done? What sorts of things should be discussed in this culture shift conversation?

Well, just look at the bonuses and compensation structures of these large financial firms. Of the firms I mentioned earlier, many of their CEO’s were paid extravagant amounts in 2011. A couple of the low ballers received about $10 million, another was paid $14 million, one received $20 million, and another $23 million. So, they are being rewarded for how they have been operating. Good show.

But, it certainly isn’t just the folks at the top. The problem is deep-rooted and more embedded in these firms. And it is a systemic problem at many places.

You see, many times the firms have been rewarding the guys swinging for the fences, the cowboys, the macho, macho men, the supposed superstars, that have been propelled by the compensation and bonus systems. If that’s the case, what are others to think? They also want to be macho, macho men. The firm’s short-term profit motive has been so wicked strong—for the next quarter or next year—that they have been risking their entire firm’s reputation and physical existence.

The bottom line is that the inducements and bonus system created a poisonous pattern in our financial corporate culture. For individuals, they have a primary quest: What can I make and how fast can I make it? But what about morals or ethics? There only seem to be puny penalties, if any, for bad behavior, but rewards for short-term profiteering.

The utter irony is this contorted belief system of “profit is everything.” That has existed and still exists at many firms, and the compensation systems propel it. But that kind of thinking won't generate the long-term gains they ultimately should seek: sustainable economic growth or real value to the business, consumers and our country.

Therefore, existing compensation structures with their perverse and cockeyed incentives need to change. Here’s how: now, risk management seems to take a second position to the profit motive. The systems currently generate inducements to escalate leverage, risky trading, and to exploit any funds at hand in the process. The systems tend to reward and promote the risk-taking folks more than others—like the risk management experts. That needs to change. Compensation systems should be fashioned upon a risk-tolerance-basis, instead of a purely profit-based structure. That would be a good place to start.

At the same time, bonuses and added compensation should take place over a longer-period of time, several years, and not simply in the given year. This would promote longer-view strategies and actions and retain better and longer-serving employees.

Remedies: Recruitment and Hiring

In addition, rather than hiring mainly the macho men, how about getting some folks who may not be the life of the party but are actually good at risk management. That means recruiting and hiring strategies need to change, in addition to the promotion and incentive programs.

The bottom line is that employees and the firms themselves shouldn’t be primarily absorbed in profit performance. There needs to be a better sense of balance between profit and risk centers. The executive suite folks need to understand and create this balance as part of the corporate culture.

Remedies: Government

As I said, government can’t be culture cops and mandate morality in financial firms, but we can set the stage for avoiding bad behavior. More importantly, we can incentivize good behavior through our laws, rules and regulations. The Dodd-Frank Act goes a long way in this regard. Specifically, we can help establish an environment in which these firms operate with appropriate transparency, integrity, and standards of conduct.

Dodd-Frank laid the tracks for us; it’s up to the regulators to get the trains running and deliver the goods. We clearly aren’t doing that on-time (we’re going on a year and a half post what was supposed to be the deadline), but I do feel compelled to point out that our agency is doing better in that regard than our brethren regulators. In total, only 30% of the Dodd-Frank rules required to be promulgated by all federal financial regulators have been finalized (119 final rules out of a total of 398). The CFTC’s scorecard shows we have a much better percentage of completed rules: 39 final rules out of a total of 60 required, or 65%.

So, the take-away here is, we have a ways to go to achieve the goals of Dodd-Frank. We’re getting there, and we’re trying to harmonize with U.S. and global regulators in our final rules to make markets safer and sounder for everyone. In that regard, here are just a few examples of what Dodd-Frank instructs us to do, what we’ve already done, and what we should do in the future.

Governance and Conflicts of Interest

In October 2010, we proposed a conflicts of interest rule that included structural governance requirements. We proposed that, for Designated Clearing organizations (DCOs), Designated Contract markets (DCMs), and Swaps Execution Facilities (SEFs), at least 35% of the boards must be public directors, and that nominating committees must have at least 51% public directors. We also proposed ownership guidelines to protect against conflicts of interest, specifically, that DCM and SEF members may not own more than 20% of voting equity. I think those are necessary, common-sense changes that reflect the objectives of Dodd-Frank. In fact, I might have proposed some stricter standards, if it were just me.

As to board structure, some financial sector boards could use a good dose of independence. Getting people who have varied views and actually getting diversity on boards can be a very valuable tool. Board independence can often breed board liberation. When I say “diversity” I do mean diversity as far as gender and race, but also diversity in skill sets.

And while we are not proposing in our governance rule that boards must be culturally diverse, I believe firms should make an effort to be representative of their current and potential customers. Boards should, in my view and to the extent practical, reflect the age, race, gender, and other similar factors of their clients. So, I encourage firms to consider cultural diversity in all hiring decisions, but certainly as part of any board member selections. Corporate boards have an important, special and symbolic significance to firms. In fact, this concept was imbedded in the Dodd/Frank Act, in a provision relating to board membership for designated contract markets. Congress put a specific provision in the law, to this effect:

“The board of trade, if a publicly traded company, shall endeavor to recruit individuals to serve on the board of directors and the other decision-making bodies (as determined by the Commission) of the board of trade from among, and to have the composition of the bodies reflect, a broad and culturally diverse pool of qualified candidates."

That’s good stuff. And, to the extent practicable, I think it is ultimately in financial entities’ best interest to reflect that kind of thinking in selecting board members.

As to ownership rules, I think these are critically important to ensure against conflicts of interest. In fact, these rules are a keystone in putting together a system that reflects the fundamental mandates of Dodd-Frank. And I know there were a lot of people who complained that our proposed ownership strictures were too onerous, but hey, the list of transgressions I went through earlier is pretty onerous—some would say odious.

I recognize there are challenges in coming up with governance and conflicts of interest rules that appropriately protect consumers and markets, and at the same time don’t impose unreasonable burdens. I guess that’s why it has taken us so long to get it done. But the time has come, and we need to get a final rule out there that does what I’ve been talking about: make sure that banks don’t put their own interests in front of their customers. It’s a fairly simple concept really—pretty much what Greg Smith was talking about—and it’s my hope and expectation that our agency will get a final rule out by the end of this year, and market participants can work on implementing our guidelines, and protect against these fundamental conflicts.

Business Conduct Standards

The Commission has already finalized a comprehensive set of standards to spell out the basic rules for engaging in this business. It’s like rules we had in school: no running with scissors; no chewing gum; no throwing food at the lunch lady. You know, the basic rules of conduct for what’s expected of you, to keep everyone safe and to make the system function as it should. And I don’t mean to trivialize these important guidelines. I just mean—with the use of an elementary metaphor—to explain the context of what we did here. Basically, these regulations lay out the “rules of the game,” and make sure that all the players are doing what they should.

With regard to internal business conduct standards, we tackled this comprehensive set of rules in phases. In late 2010, we published proposals for how swaps dealers and major swap participants should deal with confirmation, portfolio reconciliation, portfolio compression, documentation, duties, conflicts of interest, chief compliance officers, and we also proposed rules for FCMs and Introducing Brokers (IBs) in certain of these areas. In February 2011, we proposed rules on orderly liquidation provisions and documentation, and in September 2011 we proposed rules on a compliance and implementation schedule, as well as trading documentation and margining requirements. I’m glad to say, we now have final rules in place in all these areas.

As to external business conduct standards, we finalized those rules in February 2012. In brief, these “how to act with your counterparty” regulations put in place disclosure standards, prohibit certain abusive practices, and require swap dealers and major swap participants to use certain due diligence with counterparties.

Whew, that’s a mouthful. To put in brief, we now have in place the necessary rules for participation in the swaps market. If you’ll forgive another metaphor, we’ve completed the “players’ handbook.” And I know that market participants are working hard on figuring out how they will comply with each of these issues.

In that vein, I welcome—indeed, I invite—feedback from folks on compliance and implementation. I know that one of your biggest frustrations is a perceived lack of clarity as to what’s expected of you. When you bump up against those issues—please let me know. We now have, I believe, a couple hundred requests for exemptions from final rules. Sometimes these aren’t worthy; folks are just seeking to delay Dodd-Frank implementation. However, many times they are worthy and there are legitimate issues with compliance. For example, that may be when something is technologically or otherwise impractical, or if there are potentially conflicting areas of guidance, which is bound to happen in this massive undertaking. So please, when this happens, let me know. Bring a cymbal of your own. Don’t be shy.

The Volcker Rule

Finally, I want to talk just a bit about the Volcker Rule, named after former Federal Reserve Chairman Paul Volcker. What the Rule says—and this is a law, it is part of Dodd-Frank—is that banks, with some exceptions, may not trade for their house account. The point of this is to ensure that banks don’t put their own interests ahead of their customers. (We keep hearing that theme, don’t we? Perhaps because there’s a darn good reason for it). Prior to the 1999 repeal of the Depression-era Glass-Steagall Act, banks were what we traditionally think of as banks. Remember, I mentioned earlier that banks have been a necessary component of capital formation in the United States. They had customers and held their money, and made investments and loans that fueled our economy. Then again, banks do more than that—they are also risk managers, for customers and for themselves.

When Glass-Steagall was repealed, it allowed banks to engage in all kinds of trading on both sides of the fence, for proprietary accounts and for customers. That’s what Goldman and Citi did to their own customers because they—the banks—could trade for themselves. So, it created this troublesome conflict: were they trading to make money for themselves or for their customers? I suppose the two different motives could go in sync, but they don’t have to, and as it turns out, all-too-many times…they didn’t. Therefore, the need for the Volcker Rule, which essentially reverts, to a large extent, to how banks operated prior to the Glass-Steagall repeal.

Here is the problem, in my view: there is the possibility of a massive loophole as the final Volcker rule is being promulgated. You see, there is a provision of Volcker that says regulators must allow banks to trade if they are merely hedging their own risk. Under the law, under Volcker, the banks can’t speculate in the markets for themselves, but they will be allowed to trade in order to hedge their own business risk. The difference between hedging and speculating, however, isn’t always so easy to distinguish. What is being urged by some would create a large loophole—an immense breach—in the Volcker Rule because it would allow almost any trades whatsoever to be considered as a hedge.

Say I work at one of these banks and I place a proprietary trade—a hedge—for some business concern that the bank holds. What happens if that hedge gets into the money? By that, I mean, what if it turns out that the hedging trade was something that did really well, something that made a lot more money than the loss on the underlying risk. If I’m the bank and I get questioned by regulators, I simply say, “Hey, we are allowed to hedge our proprietary risk and that is what we did.”

And that’s the problem: unless we promulgate a strong Volcker Rule, the government will be in the position of going to court arguing that the hedge was a speculative transaction. I don’t see such cases going forward. The banks would hire expert economists. The government would bring in their folks—a stalemate whereby the government would have a very difficult time making its’ case. There would simply be too much litigation risk on the part of the government. You see the “wide open spaces” that such a large loophole could create would leave a lot of room, as the Dixie Chicks sing, “to make the big mistakes.” We would be right back to where we were without the Volcker Rule: banks speculating in the market and taking risks like they did leading up to the 2008 crash, and potentially taking advantage of their own customers.

Now, the Volcker Rule is a provision that amended the Bank Holding Act. The Federal Reserve has primary responsibility for that law. At the same time there are five other regulators who have something to say, or should have something to say, about how the Rule will be finalized.

I’m concerned that our agency—which has a lot of good solid knowledge and experience about what the term “hedging” actually means and how it is used in markets—ya know risk-management markets—has been fairly inaudible on what the final Volcker Rule should look like. That is why a week ago I expressed my concerns to Chairman Bernanke and the other regulators involved. I was specific in suggesting that the final rule should be clear and comprehensive in the crafting of a Volcker hedging definition.

What I said in my letter to Chairman Bernanke was that we need it soon, and we need it to be strong—not allowing for a significant loophole, and providing a clear, concise and common-sense definition of what hedging is to ensure that it does not allow speculation.

Getting the Volcker Rule correct is fundamental to ensuring that Dodd-Frank works the way Congress intended. It is at the core of the foundational regulatory changes to the financial system. Will it change the culture? No, not by itself. As I said, we need that culture shift conversation. At the same time, a strong Volcker Rule will help immensely.


One quick mention here about confidence in markets and technology. We all know that crude dropped $3 in a minute on Monday. While I can't tell you exactly what occurred yet, I can say that it wasn't a mistaken fat finger error. I can also tell you that the market was dominated with high frequency traders—the folks I've termed "cheetahs" due to their exceptional speed. The cheetahs are out there 24, 7-365 trying to scoop up micro dollars in milliseconds. They are pretty amazing and I have a lot of respect for them and the technology being used in markets today.

At the same time, I don't think technology is the best thing since sliced bread (and if you recall the importance of symbolism and baking, you'll understand how sliced bread is highly valued). But technology just ain't what it always woulda, shoulda and coulda been. We see many examples where problems have existed. The nat gas market shut down for almost an hour two weeks ago today because of some tech issues. The Tokyo Stock exchange shut down a couple weeks back due to technology problems. I've seen market volatility go nuts: nat gas dropping 8 percent in 15 seconds last year. Silver dropping 12 percent in about as many minutes. One energy trader losing $1 million in one second! We all recall the NASDAQ issue with the Facebook IPO. Knight Capital Group, in August, lost $440 million based on software trading errors. There are many more examples.

All I'm saying is that we need to be careful here. I understand some are making a lot of money using the newest gee whiz technology. Gee it’s really swell. But golly Beav, we need to ensure it actually works.

On technology, I've been trying to hit my own cymbal for a few years on this, although at times it seems like it is those dinky finger cymbals. Those are sort of goofy. My point is this: we need to be careful and I don’t think we have done enough to protect markets and consumers alike. That's why I've called for registration of the cheetahs. Can you believe they aren’t even required to be registered with us? They should also test their programs before they are put in the live production environment, and ensure they have kill switches to turn the cheetah program off should it go feral.

User Fees

Before I close, let me just briefly say a word or two about funding. I need some little cymbals for this, too. We’ve gone over a whole lot of issues today, and it goes without saying that in order to get all this done, it will require more resources at the CFTC. This is usually not a very popular subject (but that never stops me). Let’s talk user fees.

Riddle me this Batman: if you had to take a guess, what sector of our economy has experienced the most growth since the financial crisis? What would you guess: arts, autos or transportation, sciences, medicine—what do you think? Let me clue you in: it’s the financial industry. Yep, since 2008, the financial services sector of our economy has grown more than any other. There’s something sideways about that. These were the people who caused the crisis, and now they are the biggest beneficiaries.

Some may think that’s a simplistic conclusion, but there’s a compelling logic here, which brings me to user fees: why not require those who use the financial system, and who profit most by it, to pay for governmental oversight of it? In fact, the CFTC is the only federal financial regulator that is not, in some part, funded by user fees. I think the time has come to re-introduce that discussion, and come up with some solid, workable plan to stop using the U.S. Treasury to totally fund our agency, and to cover oversight costs by assessing fees on those who benefit from the industry, and benefit by our oversight of it.


That is a lot, right? Given all of that, we need to think about what is important. I hope we don’t need to call in Rossini and his cymbals from the William Tell Overture to get our attention. The devastation to our financial system should be enough for us to ensure we are vigilant in our efforts at reform, both on the government side and from the corporate side. I also understand that altering business culture and philosophy can be a lengthy, ambiguous and time-consuming process with indeterminate outcomes. That said, what has been in place isn’t working out.

Finally, I understand that this set of circumstances—what has been termed a “crisis of confidence” in our financial sector—isn’t unique to the financial sector. I can see in the mirror just like anyone else. Government is at the top of the list for systems in which people have little or no trust. As I noted earlier, however, the financial sector impacts the entire economy, so it really matters what takes place there. There is a great responsibility to act as good stewards of these businesses because they affect so many other sectors of our economy and so much of our country.

We will see what happens, right? Will folks blow it off? Will they say, “Uh yeah, that’s interesting, now let me get to what I want to talk about.” Or, will they take the time to talk about this subject seriously. We will see.

Furthermore, what will the new messages and memos from the firms say? What will be the tenor from the top? What about the beat of the board? What do they stand for? What are they all about, their mission and or corporate mandate? What do they see when they look in the mirror?

I hope they take a good, long look. Take some time to wonder and ponder about it. Then, get engaged in this important culture shift conversation.

Thank you.

Last Updated: September 21, 2012