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Volcker Rule Too Long, Say Banks, Guy Who Stayed Up All Night Summarizing It

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Apparently lawyers at Davis Polk pulled an all-nighter reading and summarizing the Volcker Rule draft that was published yesterday. And they're not the only people annoyed by the regulators' refusal to get to the point:

As people drilled down into the details of the draft, many were concerned that it appeared to require very granular policing of individual traders at banks as part of the stringent, multilevel compliance regime described in the document.

"They have chosen the most burdensome way of doing it," said Tim Ryan, chief executive of the Securities Industry and Financial Markets Association, a Wall Street trade association, in an interview.

While last night's rule-summarizing festivities undoubtedly distracted some young lawyers from the Yankees game / general yearning for death, there may be other more consequential distractions. Tyler Cowen today posits a theory of regulation:

Q = min (#laws, #regulators)

The number of laws grows rapidly, yet the number of regulators grows relatively slowly. There are always more laws than there are regulators to enforce them, and thus the number of regulators is the binding constraint.

The regulators face pressure to enforce the most recently issued directives, if only to avoid being fired or to limit bad publicity. On any given day, it is what they are told to do. Issuing new regulations therefore displaces the enforcement of old ones.

If the best or most fundamental regulations are the ones issued first, over time the average quality of regulation will decline.

The Volcker Rule was the cool new thing that came out of the financial crisis, and four regulatory agencies took it up in style, with a 200-page, Q&A-laden tome on exactly what is and isn't prop trading. You might wonder who was watching the Ponzi schemes/porn while this was being written.

More important, though, is the future implementation, enforcement, and monitoring. The SIFMA guy is right - the draft Volcker Rules require frequent, desk-level, granular, quantitative monitoring of a whole bunch of things that may or may not help distinguish "prop" from "okay" trading, and in turn that distinction may or may not correspond to "systemically risky" vs. "NBD." But if you've got seven new metrics to monitor, well, you monitor seven new metrics.

So the draft Volcker Rule is a good way for monitors from the FDIC, SEC, Fed and Treasury to spend their time talking to big banks about how much of their high yield desk's profits comes from spread and how much comes from price appreciation, or whether the $10MM of Sprint bonds that they held last quarter was really necessary to meet anticipated customer demand. Maybe that's a fine thing - if, in the aggregate, you believe that prop trading increases systemic risk, then you need to do the hard work to define it and weed it out. On the other hand, you might read the catch-all "don't do risky stuff" provisions in the rule as a suggestion that no one in Washington is all that certain that the specific, granular, quantitative factors will be all that valuable in reducing risk.

But a lot of bank monitors are going to need to spend a lot of time just reading these rules, never mind poring through banks' books to enforce them. And if their time and attention isn't infinite, that will crowd out other things - like asking "should you really be lending all this money to European banks?"

The Multibillion-Dollar Leak [WSJ]

A simple theory of regulations, new and old [MR]


The Volcker Rule Will Come Too Late For Kaufman Bros.

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: