Felix Salmon

The reactions to the Volcker-Obama bank plan seem to be veering off to extremes. On one side, the Financial Services Forum is talking about how it’s a bad idea to “preemptively break up large, well-managed, and well-capitalized banking companies”, which is wrong on two levels: no it’s not, but in any case no one’s proposing any break-ups at all. It’s also making the point that prop trading didn’t cause the financial crisis, which is true, but beside the point: the idea here isn’t to prevent a play-by-play rerun of the last crisis, but rather to reduce systemic risk more generally. And prop traders at too-big-to-fail institutions undoubtedly increasing the systemic risk in those institutions. To a large degree, that’s their job.

At the same time, the Clusterstock guys I think are altogether too sanguine about the effects of this proposal, should it get enacted. Henry Blodget seems to think it will apply only to banks and not to any other systemically-important financial institutions: we’ve made that mistake once, I’m pretty sure we won’t make it again. And John Carney thinks that simply opening up in-house hedge funds to outside clients will suffice to have those funds classified as serving customers in some way; I very much doubt that it’ll be remotely that easy. In general, it’s pretty hard to find loopholes in rules which don’t yet exist, and I’m sure that insofar as Paul Volcker is the driving force behind these rules, he’ll do his best to keep any loopholes as small as he can.

If you believe in efficient markets, the upshot is this:

That’s the stock prices of investment banks, in yellow, and regional banks, in white, over the past two days. And it’s exactly what you’d want to see if you want to see the center of gravity of the US financial system moving away from the too-big-to-fail bunch and becoming more spread out among smaller institutions.

Update: Gillian Tett makes a good point when she says that “the lack of global co-ordination potentially opens up the prospect of widespread future regulatory arbitrage” — it’s going to be hard for the US to enforce this policy on Deutsche Bank, for instance, or other foreign deposit-taking institutions with investment-banking arms. So there’s definitely a risk of much more in the way of international joint ventures and the like, which will end up being regulated by no one in particular.