January 26, 2013
The NYT told us that Bank of America made $5.7 billion from “trading” last year. It then added:
“For the sake of clarity and consistency, it makes sense to relabel this type of revenue “market-making.” That’s because it mainly represents the gain Bank of America makes when it buys securities and sells them on to clients at a higher price.”
Really? The NYT knows that it just turned out that the price of assets rose by $5.7 billion between the time when Bank of America acquired them and when they passed them on to their clients? That sounds like some pretty good luck for BoA. After all, we would expect that roughly half of the time when BoA buys an asset for a client and when it actually passes the asset on to the client the price would fall. If the net in this story came to a plus $5.7 billion that would seem like a remarkable streak of good luck for BoA.
Let’s try an alternative hypothesis. Let’s imagine that BoA was trading on its account, deliberately trying to find assets that would rise in price. If BoA has well-informed people doing its buying and selling, then it might not be too hard to believe that it could clear $5.7 billion on this sort of trading.
Of course trading on its own account would likely violate the law. This is exactly what the Volcker Rule intended to prevent. So it would be very helpful if people thought that BoA made this $5.7 billion from market-making.
Addendum:
In response to a question below, let me clarify the meaning of “trading on its own account.” A market maker must be prepared to take positions on assets for at least short periods of time in order to service its clients. This means, for example, if a client wants to sell shares of stock or some other asset, then the market maker has to be prepared to buy and hold the asset until another buyer comes along. In principle, they will pay somewhat below the market price at the time to cover the risk that the price will fall before they can offload the stock and to cover the cost of their services.
By contrast, if a bank is trading on its account it is deliberately taking a directional bet on the asset. It is not always easy to distinguish between a trade where a bank is simply acting as a market maker and a trade where it is consciously making a bet that an asset will rise or fall in price. When the Volcker Rule is firmly in place the latter will not be legal for banks like Bank of America that have government guaranteed deposits.
It is entirely possible that BoA’s $5.7 billion in trading profits were entirely due to market making activities, however that does seem unlikely since it is a substantial amount of profit on what would be a relatively small portion of the bank’s revenue. In any case, rather than assuring readers that BoA is acting in a manner that would be in full compliance with the Volcker Rule, it would seem more appropriate to simply report its claims and let the readers make this assessment, unless the NYT has actually investigated the bank’s trading practices and feels comfortable making this assurance to readers.
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