The bankruptcy of the investment bank MF Global, under the guidance of our former governor Jon Corzine, has highlighted the way the so-called Volcker Rule is supposed to protect our economy from the failure of "too big to fail" financial institutions. The Volcker Rule, which is scheduled to take effect next year, only affects institutions that are much larger than MF, but the principle is the same: Banks or financial firms that have government guarantees, or are so deeply entwined in the financial markets that their collapse threatens the entire system, should not be allowed to make such risky bets that could bring them down.
The collapse of MF resulted from unwisely betting $6.3 billion on European sovereign debt, when the firm itself had only $2.5 billion in capital. If a larger firm like Goldman Sachs had lost proportionally as much money as MF Global, and fell into bankruptcy, our financial system would be in great peril.
And the big investment banks often lose huge sums of money. As part of the research into implementing the Volcker Rule, the government looked at the proprietary-trading desks at six major investment banks. Over the 18 quarters studied, the desks turned a total profit of $15.6 billion in 13 of the 18 quarters. But in the remaining five quarters, the traders lost a total of $15.8 billion. As profitable as these investment banks usually are, when their trades go bad, they can go really bad, really fast.
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