It’s the Christmas season and this week we got the Volcker Rule. How seasonably appropriate! Now, I get the whole Christmas trade. You’re good, you get toys; bad, coal in the stocking. But this is bad in a regifted, four-year-old fruit cake sort of way. My desk now groans under the 1100 pages of Volcker whilst I’m trying to gin up some Christmas cheer – it’s not fair. We at Dechert will be sending out a more thoughtful analysis of the Rule by way of Dechert OnPoints, with more to come as the digesting process continues.
But here today, gazing at this edifice, a quick read and early reviews are a tad chilling. Given that proprietary trading, positional hedging and fund vehicle investments (collectively, “prop trading”) did not have a lot to do with the financial crisis which begot the Great Recession, it’s more than a bit ironic to see the energy, sturm und drang – not to mention lawyer billable hours – that have gone into the Rule named after the estimable Paul Volcker. And that pales in comparison to the time, cost and energy we’re all about to put into this thing, not just right now but for years to come! It’s also a little frightening that after two years, this Rule comes rumbling out late in 2013 under enormous political pressure to get Dodd-Frank done. There is nothing more likely to make an already bad rule worse than the politicians yapping at the regulators to get it done “Now!”
And, by the way, in anticipation of the Rules’ publication, many if not most banks have broadly shed their high visibility prop trading businesses that were poster children in Congressional hearings about what was bad in banking. So the major prop trading business units are gone from the major banks – it really did not have much to do with the financial crisis in the first instance – and yet we are about to start, and perhaps will never stop, wrestling with about 1100 pages of … something. This is an example, perhaps the best in quite a while, of regulatory mommy-state overreach.
If every time something bad happens we reflexively create a prescriptive structure of rules to absolutely prevent that thing from happening again, the system ultimately begins to grind to a halt, weighed down by an unsustainable complexity of rules. The Volcker Rule has been informed by the same sensibility that says since skiing is dangerous, let’s only let people on the bunny hill. Do we want to pay such a price?
Banks need to engage in transactions to make markets, facilitate customer needs and to lay off and militate risks. Let’s not forget our principal concerns about the financial marketplace are actually twofold: on the one hand, to preserve the safety and soundness of our financial institutions, and on the other, to ensure the robust viability of an effective and efficient capital formation engine for the economy. The Volcker Rule in many instances is trying to create impossibly fine distinctions between transactions which are good and transactions that are bad, and in others prohibiting fundamentally good investment structures because some of these investment structures were both popular and highly visible when the market melted down and many of these vehicles very publicly involved losses.
What happens when we try to squeeze every ounce of risk out of a thing? What happens is we get 1100 pages of rules. What happens when we get 1100 pages of rules? Government grows to try to enforce these rules, taxes go up to pay for them, corporate compliance teams and legal departments around the country bloat to try to meet them, massive transactional fiction results and we don’t do lots of things we ought to do because someone is scared that the conduct will infract, or might appear to infract, something contained in these 1100 pages.
We don’t seem to care as much as we should that all of this risk mitigation has real costs to the economy and to capital formation writ large. Actions have consequences, intended and always, always, unintended. Rules are blunt instruments. They inevitably chill innovation and entrepreneurship far beyond the borders of their intended prescriptive targets. Risk cannot be made to go away. It is essential to our dynamic economy. Making fine distinctions between good risks and bad risks is a fraught exercise. And if it takes 1100 pages to do it, it probably has failed. It’s clearly safer not to get out of bed every morning, but that’s not really an option, is it? I am so much concerned that this regulatory edifice will be hugely costly with precious little return, but somehow that seems okay to its authors.
By Rick Jones