Volcker and Banks

We have reached a crucial point in our attempt to bottle up the banks. It looks as if they will win. That means the economy will lose, and the likelihood of a new crisis immediately jumps. Read your Minsky. And weep.

There is a looming deadline in the Dodd-Frank regulations that requires rules to go into effect to govern proprietary trading. As you all know by now I am ardently opposed to banks being allowed to speculate. I refuse to call speculation ‘banking’, which is a term I like to reserve for the very dull and prosaic process of credit extension based upon sober analysis. It was yahoo trading that launched us into this crisis as banks sought short term profit at the expense of any semblance of banking rectitude – the creation of all those unnecessary derivatives in order to meet insatiable trading desk demand for commodities to move about was the ultimate reason the mortgage market mutated into a cancerous mess. Bankers still have not paid the price – personal price – for their role in casting us all over the cliff. Yes, we aided and abetted with our debt splurge, but sound credit analysis would have mitigated against our ways. We rely on banks to be measured, and not to be at the forefront of folly.

So, in my mind, it is essential to eradicate – totally – any temptation to indulge in such self destructive trading. This will not overcome the ever present dangers of credit extension. Banking will always be fraught with uncertainty, and so will never be cleansed of cyclical losses. But there is no need at all to accelerate the conflagration by adding speculation to an already combustible mix.

Banking is too important to the proper and socially beneficial workings of an economy to be left to bankers. They have amply demonstrated that they cannot, and should not, be left to regulate themselves. I say this as someone who spent more than a little time in the mid to late 1980’s writing position papers for bank lobbyists dedicated to the abolition of the twin regulations of the Glass-Steagall and the MacFadden Acts. How naive I was.

The problem bankers face is that traditional banking is pedestrian. It moves slowly. It is riven through with bureaucracy. It resembles a tedious department of the government in its red tape, rules, and other restrictions. It produces a clodden return for its shareholders. And it is hardly a stage on which a go-getter post grad business school ace wants to act.

Trading is a lot more fun. So is playing with fireworks. It is exhilarating. Dangerous. Filled will thrills and spills. And very profitable. Sometimes. The rest of the time the losses will wipe out all those gains. Over any decent span of time speculation ends up being a lot less attractive. The losses and profits tend to offset each other. The problem is that when trading gets jumbled in with banking – where margins are wafer thin most of the time – a single error can destroy years of steady progress. Capital can get swallowed up quickly. Liquidity evaporates. And bankruptcy beckons even though large swathes of the bank’s assets are sound. More importantly, such a disaster freezes the banking system, produces a credit crunch, precipitates a recession and thus swallows regular people, jobs, households and a lot else besides. We just lived through such an event. It is hardly a fictional creation.

As I said – banking matters. We need sound banks. Which means we need to reform our current banks because they are not sound. Or, at least, sound enough.

This is why trading should never, ever, co-mingle with banking.

Which is why a hard and fast ban on proprietary harding is essential as we re-build our banking system.

At the moment the bankers are pressing back against the implementation of the so-called ‘Volcker Rule’, named after Paul Volcker the former Fed chief. His rule would carve out trading from banking in a manner similar to the old Glass-Steagall Act. The banks are throwing up all sorts of dust in order to distract politicians, and are getting serious help from big business and foreign governments all of whom seem to fear a loss of market access.

Those fears are palpably nonsense.

I don’t recall big business and foreign governments having a hard time getting access to US money markets back in the Glass-Steagall era. Indeed I recall all too vividly some banks regretting being involved in sovereign lending. Nor do I recall big business being hamstrung by a lack of credit. On the contrary big business was a center of financial innovation as it developed all sorts of new funding devices to expand its way into direct market access. It was the banks fearing losing market share, not big business fearing tight credit, that drove, in part, the fight against Glass-Steagall.

This debate over the Volcker Rule is emblematic of the power struggle that sits at the heart of our economic recovery. This is a fight that we cannot lose. To do so condemns us to continued subsidy of the banking system, and to heightened risk of economic collapse in the near future. The big banks are preposterously sized with respect to even the US economy. They are grotesque giants capable of sinking us with one incorrect derivative decision. Their power has not been eroded sufficiently to rein them in. Only breaking them up will accomplish that task. Even with a full implementation of the Volcker Rule, behemoths like JP Morgan Chase, Bank of America, and Citibank will continue to lurch about the economic landscape supported by our subsidy which enables them top raise money much more cheaply and in much larger quantities than they could were they truly private organizations. Their quasi-public status allows them to make poor decisions – which they do with alarming frequency – and offload the consequences onto us. All while their managers benefit from rotten bonus incentives and lead the continued march towards greater income inequality.

This anti-social behavior has to stop. It is undermining democracy. It is ruining our economy.

Full application of the Volcker rule is urgently needed. But it is only a first step. Our bureaucrats may think they can devise subtle plans to deal with future bank failures. They cannot. All their clever plans will dissolve at first contact with a ‘too-big-to-fail’ event. The panic will force accommodation. The bankers will re-surface to pillage us again. Only breaking the banks into smaller chunks will prevent them from being the danger they became after deregulation.

The Volcker Rule is a beginning. It is not an end.