Tom Keene of Bloomberg did a fantastic interview with legendary municipal bond broker James Lebenthal last week. It’s worth a listen, but a big, unanswered question from their discussion was how the municipal bond market could become more liquid for retail investors. It was rather surprising to hear Lebenthal stumped for an answer, since Wall Street’s largest banks have been whining that if the proposed Volcker Rule were implemented, it would kill the market liquidity they provide. The rule is still being fine-tuned by federal agencies, but at its core it will ban speculative securities trading by commercial banks. However, the Volcker Rule will allow commercial banks to continue the traditional securities activities of market making and underwriting fixed income.
Jim Lebenthal and Paul Volcker are the grand old warhorses of the U.S. financial system. They have worked in and overseen banks and securities dealers for decades. They also both worked for most of their careers under Glass-Steagall, the federal banking law that separated commercial banking and securities operations, until it was repealed in 1999. Both men have implied in letters and interviews that the current structure of the market is not optimal. The Volcker Rule is a partial return to the days of Glass-Steagall.
As Volcker points out in his comment letter to the federal agencies that will implement his eponymous rule, the “liquidity” that banks claim their speculative trading adds to markets is not an essential part of financial services:
The basic public policy set out by the Dodd-Frank legislation is clear: the continuing explicit and implicit support by the Federal government of commercial banking organizations can be justified only to the extent those institutions provide essential financial services. A stable and efficient payments mechanism, a safe depository for liquid assets, and the provision of credit to individuals, governments and business (particularly small and medium-sized businesses) clearly fall within that range of necessary services.
Proprietary trading of financial instruments – essentially speculative in nature – engaged in primarily for the benefit of limited groups of highly paid employees and of stockholders does not justify the taxpayer subsidy implicit in routine access to Federal Reserve credit, deposit insurance or emergency support.