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January 31, 2012

Don't Stick US Taxpayers with Bill for Loopholes in Volcker Rule

The UK, Canada, Japan and reportedly other countries are complaining about the Volcker Rule.  They are saying that it might — MIGHT — result in the trading in their sovereign debt being less liquid.  Tellingly, they provide no data to support their argument and they make assumptions that seem to be merit less.

First, they assume if the five or so biggest US banks can’t make proprietary trades in their sovereign debt, then no one will.  That’s crazy.  Remember, the Volcker Rule only applies to prop trading at systemically significant institutions, i.e., the biggest of the big.  Everyone else can make all the prop trades they want and even take on reckless leverage, i.e., MF Global. 

Second, even the 5 biggest banks subject to the Volcker Rule are specifically permitted to engage in market making, which they could do for foreign sovereign debt, if they wanted to.  The only thing the Volcker Rule would prohibit is those banks from making big, leveraged, risky proprietary bets in foreign sovereign debt like MF Global, which would risk their failure and, unlike, MF Global, would result in being bailed out by taxpayers.  All those big banks would have to do is hedge their inventory that supports their market making in sovereign debt, which eliminates the prop trading risk both to those banks and to the taxpayers.  Market-make away, but do it responsibly as has been done by so many others for so many decades – we’re not talking about rocket science here.

Third, as basic economics teaches, when the biggest banks move out of prop trading, there will be lots more trading by other non-systemically significant institutions after the Volcker Rule.  Why?  Because there’ll be money to be made.  That’s why the biggest banks did it.  They weren’t in the business of making sure the debt of the UK and Canada and Japan were trading in deep and liquid markets.  They were in the business of making money trading that debt.  That money will still be there to be made, but the way the UK and others are talking they think that everyone else will just leave that pile of money alone.  Not going to happen.  All sorts of other institutions will step in to trade their debt and to make all that money.

Fourth, no one should take any of these claims seriously unless and until Canada, UK and Japan provide hard data to back up their completely unsupported assertions.  Unfortunately, all anyone in the industry or elsewhere has to do is say the sky will fall if you apply this rule or that rule and the headlines blare, pathetically even at the top tier media (which always seems to forget to report the self-interest behind such claims).  It’s a great disservice to do this.  It is little more than allowing press releases to dress up as a “news” story when there is no story at all, i.e., bankers crying about rules as they have done since the beginning of time.  True,  It’s a little different when a foreign country does it, but they too are self-interested and they too should have to put up some data or shut up. 

Lastly, the Volcker Rule (along with the other provisions of the law) was adopted in the US to reduce the risk of another financial crisis and US taxpayer-funded bailout.  The US is not only entitled to do this:  it has the duty to do that.  The cost of the last crisis, running well into the trillions, persists to this day, as proved by today’s headlines:  housing prices still falling, unemployment still persistently high, the Euro zone lurching from crisis to crisis, etc.

So, if the US decides to create a loophole in the Volcker Rule so the biggest and most systemically risky US banks can trade without limitations in foreign sovereign debt as requested by those countries, then the US must first get a binding agreement from those countries that they will pay the direct and indirect costs of any future crisis that arises from, relates to or was created by any type of trading or finance business from this loophole.  That seems fair.  After all, why should US taxpayers foot the bill for a crisis created to accommodate foreign countries and the trading in their sovereign debt? 

To do otherwise, would be to put the interests of foreign countries over the interests of the US, its taxpayers and its treasury.  Why would anyone do this for a speculated concern about the degree of liquidity for a foreign country’s sovereign debt? 



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