Saving the Volcker Rule
To no one’s surprise, Wall Street is about to finish off the Volcker Rule as a constraint on its business practices.
The rule is pretty simple. It says Wall Street firms that qualify for a taxpayer funded bailout are not allowed to take proprietary bets. However, from the start the related regulation and enforcement of this regulation has been needlessly complex. Together they run upwards of 880 pages!
This was not an accident. Wall Street unleashed its lobbyists/lawyers on their already captured bank regulators (primarily the Fed) with the intent to create this complicated mess. It did so with the intent of a) minimizing the impact of the regulation when it was first issued and b) identifying key passages to modify in the future so the regulation would be toothless.
Wall Street was successful at blunting the impact of the regulation and now it is moving in to defang any bite the regulation might still have.
In a much anticipated overhaul of Volcker, the Federal Reserve and other regulators are planning to drop an assumption written into the original rule that positions held by banks for less than 60 days are speculative — and therefore banned, the people said. Instead, banks would have leeway to conclude that their trades comply with the rule, putting the onus on regulators to challenge such judgments,
The most important part of the change is “putting the onus on regulators” to say a trade is a proprietary bet.
Does anyone think that by themselves regulators are up to this task?
No!
Regular readers know I have said the Volcker Rule should never have exceeded two paragraphs to begin with. Paragraph 1 says any firm that accepts deposits guaranteed by the FDIC is prohibited from taking proprietary bets. Paragraph 2 says any firm that accepts deposits guaranteed by the FDIC will release at the end of each business day all of its current exposures to show it is not taking proprietary bets.
Why the disclosure of its current exposures? Two reasons.
First, because the market is fully capable of identifying when these firms are taking proprietary bets and telling the regulators. As the rule’s namesake Paul Volcker commented: he knows a proprietary bet when he sees it.
Second, because it effectively enforces the Volcker Rule as nobody places a bet when everyone can see what they are doing. There are plenty of traders who would take positions to minimize the profitability of the Wall Street firm’s bet and maximize the losses on the bet. For example, imagine playing poker where all of your cards are face up on the table and the other players’ cards cannot be seen. When you have a good hand, the other players minimize their losses by folding. When they have a hand that can beat your hand, they stay in the game. The result is you don’t win enough on your good hand to offset the beating you take on your bad hands.
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