Thursday, February 02, 2012

The state of play regarding one key aspect of reforms that would provide a basis for growth

One of the key factors strangling growth at present is that the basic rules of play are not clear.

I hailed the Dodd-Frank Act as providing one such basic rule of play, on the basis of which growth could be soundly resumed.

But as its requirements have played out there has been intense action against each of those requirements by exactly the organisations that created the crisis.

Occasionally, I have commented on the tussle between those who want to implement the requirements of Dodd-Frank in the spirit in which they were intended and those who would like to dilute them as far as possible.

The current state of play regarding the key matter of the Volcker Rule is at:

The crux of the matter is that all the struggles since then, and all the compromises and exceptions that are now being included, which have resulted in the 298 pages of the current version, have apparently (and predictably) simply muddied the waters.

In general, the longer the draft of a regulation, the more exceptions it is trying to allow while also trying to safeguard at least something of the letter of what was originally proposed.

All that fudging ends in - guess what? - a fudge.

According to the Reuters report to which I refer above, "the divide comes down to a natural tension between attorneys writing the comment letters and traders whose activities will be curtailed". The point of the Volcker Rule was precisely to curtail those activities.

Further, the report says the split is about "the best approach to make sure the ban on proprietary trades doesn't also capture trades that banks make for their customers' benefit, known as "market making", or firms' own portfolio hedging". The Volcker Rule was clear that banks should not be making trades for customers' benefit (that should be done by other entities).

And hedging a portfolio is a bit of nonsense.

The portfolio is itself meant to spread (or hedge) risk. If that does not spread the risk sufficiently, something is wrong with the portfolio, and it is in principle wrong to then go to someone else to try to take whatever risk is there in that portfolio off you.

Portfolio managers are supposed to be paid for their expertise in spreading risk by portfolio methods.

If the managers are not good enough, they should be fired - not insured.

If you do not fire incompetent portfolio managers but seek to insure them instead, you are asking an insurance company, which does not know the portfolio intimately, to second guess someone who does know the portfolio intimately.

In principle, only an idiotic insurance company would take on such insurance.

Yet we know that insurance companies DO take on such insurance - on very large scales. And when you think of such insurance companies, remember AIG.

In America, the favourite way of avoiding genuine debate is by labelling something "communist" or "leftist".

The reporter gives away Reuters' bias by saying that the Volcker Rule was "hailed by leftists" and goes on to say: "the Volcker rule has been excoriated by the right, who warn it could take liquidity out of the market and make it hard for firms to raise capital". That was, and is, the whole point of the Volcker Rule.

Difficult as it is to think about this in the current state of the global economy, there are some kinds of liquidity that are bad.

And certain kinds of firms should not be able to raise capital too easily.

The scale of the bust was primarily because too much capital was going into speculation. Not enough capital was going into productive uses.

Capital should go to productive uses, not to speculative uses.

In other words, production should be favoured over gambling.

That is essentially what the Volcker Rule is about.

If we want to take back Capitalism from Casinoism, then it is critical to back the Volcker Rule, not fudge it.

If the regulators proceed to incorporate the sort of "discretion" that is being suggested, to be exercised by the entities that created the crash, then it is clear what will happen soon enough - another crash. And an even bigger crash. Sphere: Related Content

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