Forcing all broker-dealers to go private
I’m back! And I couldn’t be happier with the fantastic set of guest blogs from Justin and Barbara — wonderful stuff. If you haven’t read it, for instance, check out Barbara’s post on rules-based vs principles-based regulation, especially as it applies to the Volcker Rule. Volcker himself advocates a principles-based approach, contra Michael Lewis, who wants some very tough rules:
Here’s a simple, straightforward way… to construe the Dodd-Frank language, and it would reform Wall Street in a single stroke: to ban any sort of position-taking at the giant publicly owned banks.
Our crisis was not drastic enough to enable legislation that ambitious, but in theory I like this idea. Basically, it forces all broker-dealers to be private rather than public companies. That was the case before Bear Stearns went public in 1985, so it’s clearly entirely possible. And Lewis points to Citadel as a good example of a private broker-dealer dealing very successfully in the much larger and faster markets of today.
Broker-dealers as a set might well get smaller if such a rule were enforced, but that’s a feature, not a bug. In fact, if broker-dealers don’t shrink at all, then the Volcker Rule has clearly achieved nothing at all.
More generally, I suspect that a lot of people who blame Gramm-Leach-Bliley (the repeal of Glass-Steagal) for the financial crisis should really be blaming the broker-dealers going public instead. After all, Bear Stearns and Lehman Brothers and Merrill Lynch were both entirely Glass-Steagal compliant, as, for that matter, were Fannie and Freddie and AIG. The problem wasn’t that they were merged with commercial banks; the problem was that they had far more leverage than any private partnership would ever be comfortable with.
The difference between the Volcker and the Lewis view of things is this: Volcker wants to stop banks making proprietary bets when they’re so big that the government will be forced to bail them out if they lose. Lewis wants to stop banks making proprietary bets with other people’s money, period, on the grounds that no one has ever treated external shareholders’ money as if it was their own.
Broker-dealers could still borrow, of course, and would still be active in the repo markets. But bond investors are by their nature much more cautious than stock investors, and so the level of risk that the banks could take would be ratcheted down a lot. And indeed if you look back at the crisis, no privately-owned broker-dealer got into trouble. That’s partly a function of the fact that very few of them exist, of course. But a system of small-enough-to-fail partnerships is in principle much more stable than having a handful of highly-regulated public megabanks.
It’s probably sad we’ll never get there.