The Bankwatch

Tracking the consumer evolution of financial services

The Volker Rule: Allow customers decide where their money should be

This piece from Douglas J. Elliott, Fellow, Economic Studies, Initiative on Business and Public Policy at Brookings does an excellent job at highlighting what it is that investment bankers just do not get about life in the real (banking) world.

The Volcker Rule and its Impact on the U.S. Economy

First off I like the Glass Steagall/ Volker Rule approach to banking.  I believe it provides clarity and lucidity to people and allows them to frame their lending and investment approaches within their own personal context.  It also allows governments to quantify their contingent liability associated with deposit guarantees through vehicles such as FDIC and CDIC.   It further allows them to allocate money outside the ‘basic banking’ construct for additional return if they wish.

L ets look at Elliott’s arguments.  (He rightly notes that the opinions are his and his alone, not those of Brookings).

He begins with a macro point:

My core problem with the Volcker Rule is that it seems to me to be trying to eliminate excessive investment risk at our core financial institutions without measuring either the level of investment risk or the capacity of the institutions to handle the risk, which would tell us whether the risk was excessive. Instead, the rule focuses on the intent of the investment rather than its risk characteristics.

To this I say he is absolutely correct and actually makes my point for me.  Why should a Granny or a 28 year older saver need to consider “capacity of the institutions to handle the risk” when they make their monthly deposit to their savings account?  The Elliott argument to this point follows his general thread here that he looks at banking as securities/ risk oriented industry.  I say go back to Bedford Falls, New York if you want to see what banking really is.  Investment bankers have never seen this and that is not their fault.  Basic banking is taking peoples money/ savings and carefully lending it, but maintaining adequate capital to handle downside.

Lets move on to his four arguments:

Argument 1:  The globally-agreed Basel rules on bank capital take a more intelligent approach, by explicitly measuring both investment risk and the adequacy of capital to absorb those risks.

Yes of course.  But that does not make it right.  Nor is it backed by any evidence that regulators or risk managers have any competence in evaluating risk.  A 10% chance of something going south means little when it goes south and 100% is lost.  The issue with back to basics banking is to isolate undue risk from basic local and understandable risk.  More on this to come.

Argument 2:  Many supporters of the rule seem to be particularly concerned about investments made by banks which are funded with depositor money and on which the shareholders collect any gain.

At the core of this argument is the reality that ‘basic bankers’ are willing to live with low returns and do not wish to be concerned with risk/ reward calculations.  This concept is foreign to investment bankers.

Argument 3:  There is no reason to believe that regulators will be better at this than bankers, even recognizing the mistakes made by bankers in the run-up to the financial crisis.

I accept this point.  There is an arbitrariness involved in the implementation of the Volker rule.  But this argument is not enough to not pursue it.

Argument 4:  As a public policy matter, we want banks, even small ones, to hold substantial portfolios of safe and highly liquid securities so that they can meet sudden demands for cash …  A large portion of the investment losses at commercial banks in the crisis were on their holdings of securities purchased for liquidity purposes. They bought mortgage-backed and asset-backed securities that were rated “AAA” and which were quite liquid until the financial crisis struck and rendered them illiquid.

The best for last.  I cannot believe that the argument to hold MBS is held up as an argument against Volker.  Good grief.  Those toxic bonds and the promotion of them is precisely what caused the 2008 debacle.  Surely the writer cannot be making the argument that because some new fangled bond is liquid right now, that it is appropriate?  Surely not?  

Relevance to Bankwatch:

How far have we drifted from the traditional concept with the unfortunate title of ‘widows and orphans’ (look it up Mr Investment Banker).  If it seems unknown it is probably risky.  Implementation of Volker is being totally confused with modern concepts such as ‘weighted average risk’, beta, and a bunch of other investment jargon.  A good test for inclusion/ exclusion for Volker would be just that … jargon based /no jargon required. 

Lets bring some common sense back to financial services.  There is a need for utility banking whereby people have low expectations on return and high expectations on safety.  This is not a difficult concept.

Separate the high risk/ potential high return into a separate organization outside of Volker and let people who wish to play there do so.  Its very simple.  The volume of argument from the Elliotts and the Diamonds makes me wonder if they are afraid the savers will restrict their money to the utility bank and cut off cheap investment capital.

Written by Colin Henderson

January 24, 2012 at 00:55

Posted in Uncategorized

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