Volcker Rule Roundtable: Surprisingly Intelligent
May 1, 2012 Leave a comment
I promise you I was not an attendee at this Volcker Rule roundtable, although if the summary report at that link is any indication, then the Sonic Charmer School Of Volcker-Rule Obstructionism And Sneering Contempt appears to have been surprisingly well represented. Many points reportedly made there against the Volcker Rule are the same exact points my readers will recall (or won’t recall, if they’ve been skimming all those posts) I have made several times before in this space to the point of exhaustion, including:
1. There’s no clear definition of “proprietary trading” that can sharply distinguish it from market-making.
Regulators face a key challenge in distinguishing legitimate and economically valuable market-making activity from proprietary trading, which the Volcker Rule will prohibit.
(Note above that ‘proprietary trading’ is tacitly assumed/defined to be not ‘economically valuable’, and market-making is; but this is begging the question. Who’s to say that this or that ‘prop trade’ can’t be economically valuable? It has just been assumed by Volcker et al that there’s this category out there of ‘prop trading’ that is automatically ‘not economically valuable’, the only issue being to find it, and this is where their difficulties start. It’s like assuming that ghosts must exist, and then complaining about the ‘key challenge’ of ‘distinguishing’ ghosts from lens flares in your photos…you could drop the assumption in the first place if you weren’t so bullheaded…)
2. The Volcker approach to defining “prop trading” calls for mind-reading; it is not a genuinely meaningful economic distinction.
To distinguish permissible from impermissible trading, the Dodd-Frank Act appears to require an examination of the trader’s intent, but as other roundtable participants noted, regulators lack the ability to monitor traders’ brains to discern their intent. Regulators would need to find appropriate proxies for this intent requirement, but what these could be was not self-evident to a number of the roundtable participants.
Not only is it not ‘self-evident’ but no such ‘proxy’ can possibly exist. You can’t possibly objectively distinguish a trader having a position because he got hit on a market he sent out (‘legitimate market-making’) from a trader having a position because he kinda liked and wanted to have that position so he sent out an aggressive market and bought (‘prop trade’ per Volcker, I would assume). They are numerically and economically equivalent and so any attempt at a ‘proxy’, no matter how good, would lump them into the same category either way. Which again just raises the issue, why bother this artificial separation of identical risk? ‘Prop trading’ is simply not a meaningful or important thing to be trying to limit; risk, is. Perhaps. But they are not the same thing! Someone please explain this to Paul Volcker!
3. Hedge-funds-are-complaining is not a good argument against a bank’s trade.
Other participants observed that hedge funds are some of the only supporters of the Volcker Rule in the financial sector.
Stand tall, you Occupy anarchist 99%’ers! You’re on the side of those poor, downtrodden hedge funds!
4. Volcker Rule advocates are effectively arguing for expanding the shadow-banking sector, whether they realize it or not.
As banks eliminate proprietary trading and reduce their market-making activities, hedge funds and other institutions in the shadow banking sector are likely to expand and pick up the slack in these types of market activities.
Awesome! To reduce risk and make the financial sector ‘safe’, we shove more of it into shadow-banking. Golly is that Smart!
5. Volcker Rule advocates, even at their best, are pushing a sloppy and anti-rule-of-law vision of regulation that is hopelessly vague about who can get in trouble for what (answer we’re heading towards: pretty much anyone, for pretty much anything) and puts way too much power in the hands of
ignorant hard-working and patriotic regulators.
Some roundtable participants favored the adoption of overarching principles and guidelines, rather than highly specific and rigid rules. For example, one participant suggested the adoption of a customer-orientation approach as a guiding principle. If a transaction is customer-oriented, then it would be permissible. Of course, even such a principles-based approach would likely require a definition or specification of what constitutes “customer-oriented.”
*rolls eyes* Duh! Good luck with that; I look forward to your 893-page draft treatise on what defines a trade to be ‘customer-oriented’, Regulators.
6. Quite contrary to the starry-eyed motivations sometimes claimed by its proponents, one of the main effects of the Volcker Rule will be to generate a gigantic amount of basically makework jobs for a giant army of IT, risk managers, CFAs, lawyers and other 1%ers or near-1%ers who banks will need to suddenly hire in order to comply.
Lags in information technology, according to some participants, have prevented banks from monitoring on their own the inter-relatedness of these diverse financial activities and the associated risks. Alternative solutions which aggregate firm data could identify systemic risks and therefore prevent excessive risk exposure through proprietary trading. [...] many roundtable participants seemed to agree that the rule needs ultimately to lead banking institutions to think thoroughly about their entire institution’s financial risks, encouraging improvements in holistic risk-management for banking activities
This last one is just icing on the cake. I mean, I would oppose the Volcker Rule even if it weren’t true. But to constantly be told that we need a Volcker Rule to ‘rein in’ those fatcats on Wall Street, when I know full well that the Volcker Rule would be more like a jobs program for fatcats (or at least, for armies of well-into-six-figure professionals) on Wall Street, is sometimes just too much to take.
What these attendees are ‘agreeing’ in the above summary passage is that banks don’t look at their risk ‘holistically’ enough, and will have to, because of the Volcker Rule. On the surface that sounds kinda good. But the cynic in me is skeptical that this will have salutary effects in the first place, because the real result will be ‘innovation’ that ramps up risk in ways not detected by the current framework (whatever it ends up being). One can undoubtedly find plenty of glowing articles in Risk Magazine circa 2003-2007 as to how it was a golden age of risk management and banks were getting better and better at understanding their risk (using ‘technology’ and ‘innovations’ such as CDS and CDOs) in a more and more aggregated and ‘holistic’ way and so on. So, yeah, how’d that turn out? But the basic fact is that the Volcker Rule sets banks up for a gigantic additional amount of bean-counting, i-dotting and t-crossing that is (1) guaranteed to require a large headcount to get through it, and (2) of dubious value to anything tangible in the first place.
This is an argument I have been making for over a year now, but up till recently it’s been kinda lonely. Now, looking around, I find that I’ve basically won and just didn’t realize it.
The problem seems to be that we still have the damn law on the books, that (anyone reasonably-intelligent and -informed on the subject now seems to agree) is idiotic. If only the law had been passed to popular acclaim by informed legislators then perhaps I could just say ‘Well, that’s democracy’. But instead, like most of our laws nowadays, it was passed by people who didn’t know what the f**k it was, based on arguments I could see right away were full of crap, and said so from the very beginning. Where’s the roundtable discussion of that problem?