State Street and the Volcker Rule

This briefing presentation argues that State Street, the Boston-based custody bank, is the best litmus test for whether the Volcker Rule has been properly crafted.

State Street matters. Despite its relatively modest size (it is the 19th largest bank holding company), State Street is systemically important given its $19 trillion custody business, which serves as a core part of the “plumbing” of the global capital markets.  Notably, custody is a relatively low-risk (albeit market sensitive) business line, and one that, by all accounts, State Street manages extraordinarily well.

State Street embraced higher-risk, off-balance sheet investment management businesses.  During the credit bubble, State Street grew a number of higher-risk investment management businesses more typically associated with investment banks or hedge funds -- e.g. the management of cash collateral pools related to securities lending; or the management of off-balance sheet conduits that invested heavily in U.S. consumer asset-backed securities.

Higher-risk businesses pressured capital and liquidity, but taxpayers came to the rescue.  As the credit cycle turned, State Street’s non-core investment management businesses -- particularly the conduit business -- pressured the bank’s funding and capital base.  The bank ultimately elected to directly support its off-balance sheet vehicles with its own balance sheet.  The resultant pressures on both liquidity and capital were mitigated by State Street’s liberal use of taxpayer-supplied rescue vehicles -- including the TARP, TLGP, and CPFF.