What’s bad for JP Morgan isn’t bad for America

February 14, 2012
glance at the Occupy the SEC letter about the Volcker Rule before attempting to digest Andrew Ross Sorkin's column on the same subject today.

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I’d recommend that you at least glance at the Occupy the SEC letter about the Volcker Rule before attempting to digest Andrew Ross Sorkin’s column on the same subject today:

The Volcker Rule is a noble and thoughtful effort to make the banking system safer in the long-term postfinancial crisis. Critics in the banking industry, however, say the new regulation comes with many embedded costs for the national and global economy.

Here’s where Mr. Volcker and I differ. He says: “Not so.” I say: “C’mon. It’ll cost the economy, at least in the short term.”

I’m with Volcker here. And the fallacy in Sorkin’s thinking is easy to see: he’s essentially eliding big banks, on the one hand, with the broad economy, on the other. Yes, Sorkin is right that the Volcker Rule comes with “significant costs”. But there’s a difference between costs to a handful of banks, and costs to the economy.

If and when prop trading leaves the big banks, those banks will make less money. That’s by design. But the money doesn’t just disappear. Insofar as trading is a zero-sum game, and it certainly has that component, lower profits at the big banks mean higher profits everywhere else. And insofar as trading takes place outside regulated banks, at hedge funds or small broker-dealers without access to the Fed discount window, some of the profits will simply move there, to small-enough-to-fail institutions.

In other words, there is a list of institutions which will be harmed by the Volcker Rule. Here it is: JP Morgan Chase, Bank of America, Citigroup, Goldman Sachs, Morgan Stanley. These institutions should get smaller. These institutions should be less profitable. There’s no reason to believe that when that happens, the economy as a whole will suffer.

There’s also the question of whether the Volcker Rule will hurt liquidity, and whether that would be entirely a bad thing. Sorkin happily parrots the rather ridiculous Sifma number saying that the costs of the rule could reach $350 billion. “Even half that number has to be considered substantial”, he writes, as though the best way of making a ridiculous number accurate is to simply divide it by two.

Sorkin quotes Volcker on the baseless “presumption that ever more market liquidity brings a public benefit”, but he shares that exact presumption, for no good reason. Where, exactly, is the public benefit in me being able to buy and sell stocks hundreds of times per second? Where is the benefit in bringing down trading costs to the point at which people stop thinking before they act? Liquidity is like a safety net: it allows people to feel free to make potentially stupid decisions, because they know they can always change their mind and reverse those decisions at any point. Until, of course, there’s a crisis, and correlations spike, and the safety net, just when you need it, isn’t there.

Sorkin worries that it will become “impossible, or at least, impossibly expensive” for banks to warehouse merchandise in the form of securities available for sale. He doesn’t, on the other hand, explain why that’s a bad thing. Why should commercial banks be America’s largest market-makers, with enough clout within Sifma and other industry forums that they can set the broad anti-Volcker agenda? There’s no good ex ante reason why that should be the case, and indeed commercial banks have only truly dominated the market-making world in the past few years, since Goldman Sachs and Morgan Stanley converted after Lehman went bust in 2008.

If you dig deeper into the complex needs of global corporations that are the clients of big banks these days,” writes Sorkin, doing his best Jamie Dimon impersonation, “they sometimes seek banks to make proprietary bets to help them.” Unpacking the pronouns here, I think that what Sorkin is saying is that somehow big corporations want banks to make proprietary bets, because banks’ proprietary bets somehow help those big corporations. I don’t see it — and neither does Volcker.

Yes, the Volcker Rule would hurt America’s biggest banks — and yes, those banks do have extremely large corporations as clients. Once the Volcker Rule is implemented, those extremely large corporations might find their Treasury needs best served by smaller brokerages. They might even see more competition for their dealflow, once the bigfooted giants are forced out of the game. There’s no reason to believe that the extra competition would also mean higher prices or wider spreads. So let’s concentrate on making the Volcker Rule as tough as possible, and stop worrying about its effect on Jamie Dimon’s annual bonus.


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