CEPR - Center for Economic and Policy Research


En Español

Em Português

Other Languages

Home Publications Blogs Beat the Press NYT Cleans Up Bank of America's Books

NYT Cleans Up Bank of America's Books

Saturday, 26 January 2013 08:28

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.



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.

Comments (7)Add Comment
written by skeptonomist, January 26, 2013 9:04
The stock market typically does not maintain a constant price level, but tends to move steadily in one direction or the other for varying periods of time. So there should be periods in which BoA consistently makes money from the rise in price of stocks it temporarily holds, and other periods in which it loses. Since the average price moves up in the long run, BoA should make a net profit over a long period encompassing several cycles. Anyway, given the average length of time BoA holds stocks and the average amount by which the market has moved up (or down) in a given period it should be possible to determine whether BoA is beating the market. I am skeptical that BoA could actually beat the market just by trading, since on average mutual funds do not. If BoA has inside information that is a different matter.
The books
written by David, January 26, 2013 9:42
For the sake of clarity and consistency, it makes sense to say that the writer had no idea what market-making is.
What is "trading on its account"?
written by Melissa, January 27, 2013 7:57
Please explain what "trading on its account" means. Dean, you're usually incredibly good at writing for well-educated lay people, but you just fell into inside-baseball-speak with this one.
written by JSeydl, January 27, 2013 2:58
The issue is that it's very difficult to separate MMing from prop trading. Every MM has a view on the direction of future market movements, and those views influence how the MM's book will be organized. Sure, many banks have internal hedge funds, which the Volker rule will outlaw. But the idea that the Volker rule will stop banks from taking directional bets is nonsense.
written by Yeltstin, January 27, 2013 3:43
Actually, when you make a market you're offering to buy a bit below the equilibrium price and sell a bit higher than the equilibrium price. So if the market does move against the market maker's position 1/2 the time, the MM is still in a position to scratch 1/2 the trade and make a profit on the other half. No luck necessary.

Which is not to say that BofA isn't trading on spec, they probably are. What this really shows is how toothless the Volcker Rule is if you're going to allow market making.
written by George Hartzman, January 27, 2013 8:24
I am the George Hartzman Rolling Stone's Matt Taibbi wrote of the other week, and I believe Wachovia CEO Robert Steel bought Wachovia’s stock in a breach of trust, confidence and his fiduciary duty to shareholders, US taxpayers and our legal system, while in possession of material, nonpublic information.

On July 9, 2008, Robert Steel became president and CEO of Wachovia after working for Goldman Sachs from 1976 to 2004 and the US Treasury under former Goldman Sachs CEO Henry Paulson from October 10, 2006 until July 9, 2008. Mr. Steel was “the principal adviser to the secretary on matters of domestic finance and led the department's activities regarding the U.S. financial system, fiscal policy and operations, governmental assets and liabilities, and related economic matters,” according to Wikipedia’s biography. Mr. Steel most likely knew about other firm’s borrowings via his time spent at the U.S. Treasury Department.

On July 22, 2008, Mr. Steel personally purchased 1,000,000 shares of Wachovia’s stock as the company’s undisclosed Federal Reserve Term Auction Facility (TAF) borrowing reached $12.5 billion, which appears not to have been disclosed in securities filings audited by KPMG.

In an interview with CNBC's Jim Cramer On Monday, September 15, 2008, Robert Steel said "I think it's really about...transparency. People have to understand the assets and really be able to say, this is what I own... Complete disclosure. ...we can work through this with transparency, liquidity and capital. ...Our strategy was to give you all the data so you could make your own model. We tell you what we're doing... ...we're raising capital ourselves by basically shrinking the balance sheet, cutting the dividend, cutting expenses. We can create more capital ourselves that way... for now, we feel like we can work through this..." After Jim Cramer asked "Should there be any sort of quick regulatory relief from the SEC that would make life easier to be able to make your bank much stronger?", Mr. Steel responded "I don't think it's about my bank."

After not reporting TAF loans, Wachovia's CEO wrote "I, Robert K. Steel, certify that: I have reviewed this Quarterly Report on Form 10-Q for the quarter ended September 30, 2008 of Wachovia Corporation; Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report" on October 30, 2008.

Mr. Steel was at least aware of Wachovia’s Federal Reserve loans since July, 2012, if not the undisclosed loans to multiples of other financial institutions.

If Mr. Steel was “the principal adviser…on matters of domestic finance and led the department's activities regarding the U.S. financial system, fiscal policy and operations”, how could he not have known and acted on undisclosed material information?

On June 22, 2010, Robert Steel was appointed Deputy Mayor for Economic Development by New York City Mayor Michael Bloomberg, after which, Steel resigned his seat on the Wells Fargo board. According to Morningstar data, Mr. Steel owned 601,903 shares of Wells Fargo in 2010, which would be worth $20,446,644.91 as of October 26, 2012.

George Hartzman
Greensboro, North Carolina
Explanation of what your looking at...
written by Jim, January 27, 2013 9:21
There are 3 divisions that handle the capital markets within B of A. Global banking comprising of commercial banking and a majority of the investment bank, global markets which handles institutional trading and has part of the investment bank revenue under an agreement with global banking; global wealth management which handles retail investors. Finally, there is group of private equity vehicles which are filed under other income that were marked up1.1 billion last year. Institutional market Making accounted for 1.82 billion for the year just ended. TrAding profit was 5.706 billion, 2.2 billion of ibank revenue and 3.3 bullion of net interest income which should be included with trading profit. Net income for global markets was 5.725 billion. Both trading profit and market making was down as b of a has targeted ibanking first in their cost cutting initiatives. And the volcker hasn't been fully implemented and as I understand it, would allow trades less than 60 days, and certain types of hedging which banks could game.

Write comment

(Only one link allowed per comment)

This content has been locked. You can no longer post any comments.


Support this blog, donate
Combined Federal Campaign #79613

About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.