Only fight the battles worth fighting ..... the Volcker rule can go

Only fight the battles worth fighting ..... the Volcker rule can go

ref :- "Drop the Volcker rule and keep what works" , The Financial Times, Leader

Few would argue that substantial regulatory reform wasn't essential after the financial crisis of 2008. In the poisonous atmosphere of the time even fewer had the appetite to publicly challenge  even the elements of the resulting Dodd-Frank reform package that they believed to be misguided. For the most part, if you were a banker or an investment manager say, it was time to keep your head down. But in the years since, certain market events  --  flash crashes and taper tantrums for example  -- have illustrated the liquidity problems that are the result of the new legislation, and allowed a healthier debate about whether some of the measures are such a good idea, or whether they in fact increase the risks to investors.

One such measure is the Volcker rule, named after the former chairman of the Federal Reserve Paul Volcker. The Trump camp has been nothing if not forthright about their intention to drive a coach and horses through the Dodd-Frank legislation, which is a concern to many, but their efforts to scrap the Volcker rule in particular will garner much more support. The FT editorial, which let's face it is often partial to assuming the moral high ground, is in favour of doing away with rule for stunningly pragmatic reasons on this occasion. Firstly, because it has quickly become nigh impossible to apply and secondly, because it's worth sacrificing if helps to defend other, more crucial elements of Dodd-Frank.

To quote the FT : "The Volcker rule was intended to prevent banks from using depositors' money to make risky trades for their own account  --  lowering the chance that a bank, damaged by a trade gone bad, would seek a government bailout. The rule's framers also decided to allow deposit-taking banks to trade in the market on behalf of clients. Market-making requires holding an inventory of securities for shorter or longer periods. This in turn necessitates hedging trades to keep the bank's own net exposure down. The resulting activity is so complex that telling speculation from client service is often a fool's errand."

Quite so ..... but the most widely-held reason to repeal the rule is that it adds to an already dangerous lack of market liquidity in times of stress that causes violent short-term market moves. The rule's ambiguities mean that banks are reluctant to hold inventory, and without that inventory banks cannot as buffers between buyers and sellers to smooth market action in times of duress. Actually, the FT is a little sniffy about this as a reason. There were numerous occasions of markets drying up before the Volcker rule was implemented, it is argued. That's true of course, but maybe misses the point. Nobody is saying that absences of liquidity won't occur after repeal (of course they will), but in markets so often driven by algorithmic computer signals any measure that would make them less likely should be encouraged.

This liquidity issue is crucial ..... rafts of banking legislation since the crisis have already made it hugely expensive and difficult to remain compliant. For reasons of economies of scale, this has the effect of pushing out smaller operations and concentrating business in fewer, bigger hands, which not only causes problems of liquidity but also of competition, or rather the lack of it.

You could easily make the case that the higher capital requirements today protect the banking system to such an extent that much of the Volcker rule is redundant anyway. It is simply too costly to trade your own book under the new legislation, which is why European banks have pulled back from proprietary trading even though they do not come under the Volcker rule. That being so, says the FT, if you're a supporter of strong financial regulation why not ditch Volcker in return for something else ? Maintaining or even strengthening the commitment to high capital requirements, for example ?

It's a fair plan ..... although so far the Trump administration does not give the impression of being open to that sort of compromise.