In the FT, Paul Volcker defends the Volcker Rule:
Is there really a case that proprietary trading is of benefit to the stability of commercial banks, to their risk profile and to their compensation practices and desirably fiduciary culture? I think not, and we need to look no further than Canada for a system in which its large banks have been much less committed to proprietary trading than a few US giants. In any event, there are and should be thousands of hedge funds and other non-bank institutions ready, willing and able to undertake proprietary trading in unrestricted securities in large volumes. The point is that those traders should not have access to the taxpayer support implicit in the safety net of commercial banks.
I’m amazed Volcker couldn’t do better than this. First, if nothing else, during the runup to the housing collapse the “benefit to the stability of commercial banks” provided by proprietary trading was he fact that those proprietary positions were largely invested in something other than subprime mortgages. Proprietary trading by the big banks played no role in bringing the U.S. financial system to the brink in 2008. The problem was just the opposite: the banks were nearly done in by assets they thought were the safest: those gilt-edged, AAA-rated mortgage securities banks were creating and selling to investors. Virtually all the big banks owned them, and in size. So when mortgage credit began to crack, everyone owned the same type of rotting assets and was momentarily at risk of all going down together. It was what Peter Wallison calls a “common shock.” Prop trading had nothing to do with it. If anything, the desks provided a measure of needed diversification.
That’s the benefit proprietary trading can provide. The more different businesses (including prop trading) a bank is involved in, the less likely that any single business will put the enterprise at risk. It is basic, and obvious. Don’t they teach this stuff in business school anymore?
Meanwhile, Volcker seems to concede that proprietary trading and market-making are worthwhile activities (he has no problem with hedge funds and other non-banks getting into them). If it’s good enough for non-banks, why then not banks? They have the expertise and the capital. And for me, at least, one common shock per lifetime is plenty.
What do you think? Let me know!