You can – but shouldn’t – read some overheated complaints about how bankster lobbying weakened the Volcker Rule from I guess its platonic form of “anyone who does anything that, in hindsight, looks sort of like prop trading, will be shot.”* One problem with that is that it rests on a somewhat crude theory of lobbying, as just going to a regulator and saying “I want you to do X because it is good for banks and look I am holding a bag with a $ sign on it how about that.” In fact though effective lobbying by a bank involves (1) good arguments, and (2) because everyone just hates banks, reiteration of those arguments by sympathetic non-bank supporters.
U.S. banks pushed regulators to widen proposed restrictions on trading and hedge-fund ownership by foreign firms, then encouraged governments around the world to complain about the rule’s reach.
The two-pronged lobbying strategy resulted in foreign officials joining U.S. lenders to push back against the Volcker rule, named after former Federal Reserve Chairman Paul A. Volcker and incorporated in the 2010 Dodd-Frank Act.
It’s so good! Step one: appeal to patriotism to convince US regulators that any Volckery needs to apply to foreign banks so that Jamie Dimon doesn’t have to like decamp for Sealand or whatever. This is a reasonably good argument, in that there’s no particular reason that US rules should weaken the competitiveness of US banks when they can be applied more universally. Step two: appeal to foreign governments to convince US regulators that the application of Volcker to foreign banks, and to trading in government securities (except US Treasuries!), will drive up their financing costs at exactly the wrong time. These are … well, they’re plausibly sympathetic supporters, anyway. Read more »
If you’re a more or less regular consumer of efficient markets hypothesis Kool-Aid then a fun activity is to handicap the probability of various public policy things based on market reaction.* So for instance Obama’s budget is going to reduce the tax deductibility of munis! And the muni market didn’t care! So, no, Obama is not going to reduce the tax deductibility of munis. You heard it here first, or last, or whatever. (Exercise for the reader: is Obama going to raise the tax rate on dividends?)
Since today seems to be Volcker Day hangover it’s worth pondering this: Read more »
I guess this is a thing? Today is the last day to submit comments on the Volcker Rule so hurry!* No less than Paul Volcker himself was roused from 25 years of slumber to submit his own comment, and while he was up he laid a gleeful smackdown on European governments. You may recall that some clients had some concerns about the Volcker Rule reducing liquidity, with some of those concerns being less sympathetic than others, and foreign sovereigns were among the noisiest complainers. Volcker is having exactly none of it:
There is a certain irony in what I read. In Europe, there are plans to introduce a financial transaction tax, justified in part by officials because it puts “sand in the wheels” of overly liquid, speculation-prone securities markets. … How often have we heard complaints by European governments about speculative trading in their securities, particularly when markets are under pressure?
There’s a juicy pile of something going on over on Maiden Lane. Once upon a time, Goldman Sachs murdered AIG and stuffed its corpse with tons of shall we say “troubled” residential mortgage-backed securities. Like a cursed diamond, those securities then bounced around among owners who came to bad ends and ended up in a thing called “Maiden Lane II,” owned by the New York Fed and managed by BlackRock, with a mandate to sell them off over time at prices that “represent good value for the public.”
One day, Credit Suisse came to BlackRock with reverse inquiry for those Maiden Lane II bonds. The Fed via BlackRock solicited bids from five banks, CS, Goldman, Barclays, RBS and Morgan Stanley. The banks conducted some pre-bidding price discovery with their clients, though they were sworn to secrecy and had to get the clients to sign nondisclosure agreements before they could solicit them. Eventually the banks put in bids and Goldman won and bought the bonds, and is now selling them rather nonchalantly to clients, keeping most of them overnight after buying them from the Fed.
A simple story, but it raises two interlinked things to worry about:
(1) Why are you giving all those wonderful wonderful bonds to Goldman, huh NY Fed? HUH?
(2) Why are you keeping all those deadly deadly bonds on your balance sheet, huh Goldman? HUH?
If you’re in a certain line of work, and I bet you are, then your main concern about things like the Volcker Rule and increased capital requirements for banks is that they might reduce your comp. If you’re in that line of work, you’re also probably the sort of person who has a higher than average aversion to having your comp reduced. However, you’re also the sort of person whose comp everyone else would be happy to see reduced, because you make too much already you greedy jackass.
That poses a quandary because nobody’s all that interested in hearing your arguments against the new rules, even if they’re good arguments and not 100% about your own personal remuneration. One thing you could do is get proxies to make your arguments. If you think that the Volcker Rule will reduce liquidity in foreign government bonds, you could suggest to foreign governments that it’s really important that they lobby against the rule on your behalf. You did that. Good work. Let’s see how it turns out. If it turns out well, the next step would be to get other clients to say “well, we want liquidity in our [stocks/bonds/rate swaps/whatevers] too,” since that would then be a more compelling argument.
Yet finance ministers from around the world lined up to whisper in the ear of Timothy Geithner, the Treasury secretary, who made the rounds in Davos on Thursday and Friday, about a specific element of the Volcker Rule that has them apoplectic: The rule says that United States banks — and possibly certain foreign banks that do business in America — would be restricted in trading foreign government bonds. Yet the rule, conveniently, provides an exemption for United States government securities. Every other country is out of luck.
The measure, critics say, is likely to increase borrowing costs for foreign governments, reduce liquidity and make the market for foreign government bonds more volatile, the opponents charge. In the end, it may fall into the category of unintended consequences of a proposed new regulation.
The Volcker rule is, in many ways, a riddle wrapped in a mystery. It is impossible to know what the impact on market liquidity will be. Foreign banks, or non-banks, may step into the fray to pick up the slack… or perhaps the impact of the rule won’t be that big on US banks, anyway. Without a set of final rules, a period of time to watch them in action, and a parallel universe to see what would have happened if they hadn’t been implemented, it’s all speculation.
Again, I come down on the side of robust market-making by banks being a good thing and so I suspect those lined-up-and-whispering finance ministers are right, but it’s also true that that’s just, like, my opinion, man, and nobody really knows what will happen but if I were Citadel I’d be lobbying like crazy for the Volcker Rule and promising European governments that I’d make awesome tight markets in their bonds. Read more »
We’ve talked a bit before about the Volcker Rule and how it’s going to have creepy unintended consequences because it is really hard to distinguish “market making,” which is what bank-broker-dealers are supposed to do, from “proprietary trading,” which is evil and destroyed the world. Today we have an excuse to talk about it again because (1) Uncle Vikram sort of shrugged off a question or two on it on this morning’s Citi earnings call, though he’s not quite in the Jamie Dimon camp of “I can’t hear you there will never be a Volcker Rule shut up shut up SHUT UP”; and more relevantly (2) Stanford finance professor Darrell Duffie just put out a study saying that the Volcker Rule is going to have creepy unintended consequences because it is really hard to distinguish “market making,” which is what bank-broker-dealers are supposed to do, from “proprietary trading.” Don’t be distracted from the rightness of this study (obvs!) by the fact that securities industry trade organization SIFMA paid Duffie to write it.* Instead, let’s focus on the important questions, like: where is my $50k check from SIFMA?
Much of this paper is a full-throated, conventional defense of Grossman-Miller market-making, which is nice and will bring a tear to your eye if you’re a market maker: Read more »
Sheila Bair, former head of the FDIC and cartoon-klutz-villain of Too Big to Fail, comes in for the occasional gentle ribbing on Wall Street, and her column in Fortune today is well set up for another round of gentle ribbing, which I will get to in just a minute, so you might think that that headline was intended to make fun of her, but actually, no, she makes a solid point:
MF Global took proprietary positions in European sovereign debt through what Wall Street calls “repo to maturity” transactions. It technically sold the European bonds to other firms, agreeing to repurchase them at a premium when they matured in 2012. MF hoped to make money by pocketing the difference in the rate it paid its trading partners and the higher rate paid on the bonds themselves. … Under the 300-page Rube Goldberg contraption of a regulation recently proposed by federal agencies to implement the Volcker Rule, “repo” transactions like MF Global’s are not generally treated as verboten proprietary trades. Thus, even if MF Global had been a bank, it arguably could have used this exception to gamble away, putting the FDIC at risk.
Now, if I had to guess, I’d say the better side of the argument is that the MF sovereign trades would in fact be streng verboten under the Volcker Rule. (Except, of course, as she points out, that MF is not an FDIC insured bank and so is not covered by the Volcker Rule.) I read the rule’s coverage of “any long, short, synthetic or other position” in a security to include the Corzine repo-to-maturity, which is at least a “synthetic position” in the underlying debt, and since the position seems to have been more “prop” than “flow” it would probably be prohibited. But I had to search around in the proposal for some time to come to that conclusion – it’s not apparent even from the mammoth Davis Polk flowchart that has replaced the actual rule text for my day-to-day Volcker Rule pondering efforts. And the meaning of “synthetic” may not be the same to everyone. So I’ll spot her the claim that a bank could “arguably” use a repo-to-maturity structure to prop trade to its little heart’s content. [Update: A lawyer I trust points to the Volcker Rule’s “repo exception” for trades arising out of repo agreements; he thinks that Bair is right that the MF Global trades would fall under the exception and not be covered by the rule. I suspect that the intent of the “repo exception” is to cover the people providing the repo funding (here MF’s counterparties), not the people with economic exposure to the position, so I’ll tentatively stick to my original claim, but in any case the murk is even murkier than I’d thought. By the way, if I’m wrong, then things are even worse than Sheila Bair thinks. Basically any prop trade is fine as long as you fund it via repo.] Read more »
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