Parsons on Volcker Critics
March 30, 2012 Leave a comment
John Parsons of MIT has some thoughts on Volcker Rule criticism. Let’s see what he has to say! As you may not be aware (I can’t remember whether I’ve mentioned this) I have been known to have some opinions on the Volcker Rule myself!
The Volcker Rule bans banks from proprietary trading. But the Volcker Rule does not ban anyone else from proprietary trading. The IHS report assumes that when banks stop proprietary trading, no one else will step in and do so.
That’s a ridiculous assumption. Let’s look at other industries where governments sometimes regulate which institutions may and may not operate …
Right off we have a disorienting category error. ‘Proprietary trading’, if it means anything at all (and I’m not sure I think it does), means trading by banks (‘for their own account’). Even the lowliest Reuters reporter knows how to wiki that. So when a non-bank buys things we don’t have to call it ‘proprietary trading’, we just call it trading. So what is he talking about? Does he know what ‘proprietary trading’ even is?
Parsons is certainly correct that other institutions besides banks can engage in trading. For example, hedge funds. Pensions. Insurance companies. Rich a-holes. The Fed. He’s also right that banks spin off prop desks. But that is the case today; they already do. The point is not that there’s some generic activity called ‘proprietary trading’ that could be done by anyone, and we’re just banning banks from doing it, meaning those other guys could ‘start proprietary trading’ (they already are!). The point is that we’d be banning (or at least trying to ban) banks – a large market actor that currently provides much of what little liquidity there is – from much of the trading they do. It’s fair to question how important ‘liquidity’ is, but the idea that this will have no effect on liquidity is ridiculous at best. When it stems from this disorienting notion of ‘proprietary trading’ as something that ‘others could step in and do’ I don’t even know what to call it, besides ‘unclear on the concept’. The issue is whether a specific large institution called a bank can trade (i.e. in a way that retains inventory/risk) or not and the Volcker Rule, interpreted literally, says ‘not’. Of course that will have an effect.
The only way to salvage his point is to interpret Parsons to be saying that he thinks that once the Volcker Rule is in place, someone such as (say) regional broker-dealers will ‘step in’ and suddenly decide to use balance sheet/hold significant inventory in a way that makes up for banks not doing so. In other words, become combo hedge funds/market-makers. I find this highly doubtful and he gives no reason to believe it will happen, but if that’s what he means I’d be curious to hear why.
IHS['s evaluation of the Volcker Rule] ignores taxpayer subsidies to banks.
Here’s one example. Unmargined OTC derivatives sold by banks entail credit risk. But, pre-Dodd-Frank, banks did not properly account for that credit risk. They could ignore or minimize that credit risk in their reports to their regulators, and, as a result, they didn’t have to hold capital against it. The capital backstopping the risk was taxpayer capital, and banks didn’t pay for it. They only profited at taxpayer expense.
Counterparty risk is a major component of Basel III capital rules now, Volcker Rule or no Volcker Rule. So if this is an argument for something, which it may be, it’s not the Volcker Rule.
Protecting hidden subsidies to banks is not a sensible economic policy. The U.S. economy is still paying mightily for that mistake.
I think I agree with this part! The problem is, and always has been, that the reason we’re paying for it has nothing to do with those banks having done ‘proprietary trading’. Again, just because something bad happened, and you think ‘proprietary trading’ is bad, doesn’t mean bad #2 caused bad #1. That’s Platonist thinking rearing its ugly head again.
The Volcker Rule is about ending hidden taxpayer subsidies to risky transactions by banks.
It is? So (1) the Volcker Rule bans making loans? Or (2) loans aren’t risky? (Anyone agreeing with the above statement has to pick one.)
That was always what it was about. From the very beginning.
I don’t know whether that’s what it ‘was about. From the very beginning’. I do know that that’s not what it actually does. What it actually does is define, and then ban, an arbitrary subset of activity it calls ‘proprietary trading’ – not ‘risky transactions’.
Banking is a risky transaction. Does Dodd-Frank ban banking, Prof. Parsons?