Whither the Volcker rule? After a flurry of discussion about it in the wake of JPMorgan Chase’s Fail Whale trades, we’ve heard significantly less of late. In fact, regulators blew through a July deadline on finalizing the Volcker rule. The last word we had was that the deadline was pushed back to the end of the year.

More time means more opportunity for big banks to lobby over various exemptions. And that’s just what they’re doing, attempting to take a little loophole they found in the initial language and blow it wide open.

Banks are urging U.S. authorities to broaden a little-noticed exemption in the Volcker rule’s trading curb that critics say could blind regulators to the next version of the JPMorgan Chase & Co Whale trade [...]

The exemption covers a special type of account, designed to prevent the kind of cash crunches that took down Bear Stearns and Lehman Brothers in the heat of the 2007-2009 financial crisis.

Banks want an even broader exemption. But critics say the proposed rule, as is, already excludes liquidity trades almost entirely from the Volcker rule, expected to be finalized later this year.

As is, the liquidity exemption “deeply undermines the applicability of the Volcker firewall,” Democratic Senator Jeff Merkley, one of the authors of the Dodd-Frank provision authorizing the rule, said in an interview.

Merkley believes that banks could use this exemption to hide bets like the ones in the Fail Whale trade. Of course, the banks are saying they must broaden this exemption or their banks will fail entirely.

It looks to me like banks want to preserve the ability to use these liquidity accounts to make proprietary trades. This way, they could ensure a highly liquid menu of assets and securities and turn them over in case of a cash crunch. But this exempt account could be so easily gamed, and would almost certainly get used as a profit center instead of a means for liquidity management (usually this is done by lowering the maturities on a basket of securities, so they can be exited more quickly). This idea that you can’t have a liquid portfolio unless you make risky proprietary trades is really nonsensical.

Hilariously, JPMorgan Chase is the major bank pushing for this. In fact, Ira Drew, who used to head the infamous Chief Investment Office that put together the Fail Whale trades, met with regulators to lobby for this exemption in February, before the trades came to light.

The banks basically want to find an account that they can use for the purposes of casino playing, and will make up any excuse – hedging! market-making! liquidity management! – to get that account legalized. Considering that the regulators continue to back off actually writing the rules here, it’s likely the banks will be successful.