Volker Rule Diverts Attention from Fraud
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"I believe that the officers, and, especially, the directors, of corporations should be held personally responsible when any corporation breaks the law."
– Theodore Roosevelt, speech at Osawatomie, Kansas ("The New Nationalism" August 31, 1910)
For a while now I have been saying that the Volcker Rule is a bad idea. I share the respect and admiration we all have for its namesake, former Fed Chairman and full-time public citizen Paul Volcker. But Volcker has never been a hawk on bank superivision, especially when it comes to large banks like his former employer Chase Manhattan Bank. I called Volcker “the father of too big to fail” in my 2010 book, Inflated: How Money & Debt Built the American Dream. The eponymous rule that now terrorizes much of the financial industry is thus especially incongruous and for the following reasons.
The Volcker Rule seeks to forbid banks from acting as principal in the financial markets for tactical trading gains of any time duration, limiting the investments by the bank to held-to-maturity positions for the corporate treasury. Most of the comments by the industry, media and other observers have focused on the sales/trading area of the large universal banks affected by the Volcker Rule, but the changes imposed by this draconian prescription also impact the activities of the investment side of the house. Hold that thought.
In conceptual terms the Volcker Rule is a step back towards the 1930s era Glass-Steagall separation of investment and commercial banking, but only a half-step and this is the crucial point. The Volcker Rule imposes activity limits on the entire bank without separating the agency and principal functions into different corporate buckets with separate capital in a legal and financial sense. The Volcker Rule focus on imposing the limitation upon the whole organization does great mischief, as noted by the hundreds of public commenters on the rule. A good summary of the Volcker Rule from Skaden Arps is below:
Keep in mind that most of the capital in a bank is meant to support principal risk taking by the bank, not customers, in the form of either lending or investing, while the agency activities for customers such as brokerage, trust and asset management are relatively less capital intensive, like an order of magnitude less. By not bifurcating the capital inside the large universal banks between the majority of which is supposed to support principal risk taken in the credit markets and that lesser portion needed to support customer facing activities, the Volcker Rule by definition must reduce liquidity to the financial markets. All together now: “Duh.”
Last week I spent a couple of hours listening to the head of credit risk at one of the largest banks in the world describe how his lawyers are caught in the crossfire between federal bank regulators and the SEC over what constitutes principal trading for purposes of the Volcker Rule. Of note, a related issue being brandished with great effect by the bank's tormentors at SEC is whether a bank is trading its own account based upon material non-public information (MNPI) under any circumstances.
Under the Volcker Rule, the bank cannot make markets in any of the securities it has traditionally traded. If the bank does make a trade for its own account, it must not only justify the action under the Volcker Rule limitations, but must also prove that neither the bank nor its counterparty were in possession of MNPI. Even if a party inside the bank unrelated to the trade had such MNPI, the bank's lawyers or regulators might object. Thus the investment side of the bank has been presumed to be guilty and as a result is shut down completely.