Volcker Rule: They Shoot Horses, Don't They?

If the Volcker Rule were posited as a panacea, much of the criticism that has been leveled by the bank lobbyists and their congressmen, and sincere critics who were surprised by its ungainly introduction into the reform deliberations, would be correct. However, I do not think it was, but I could be wrong.

Because a cure for heart disease does not also cure diabetes does not impugn its effectiveness in curing heart disease. And if the patient has both heart disease and diabetes, one might expect a variety of remedies used in careful combination.

What the Volcker Rule would have accomplished is to take the gamblers away from the new “discount window” of Fed and Treasury subsidized programs. It would have also put a serious dent in the ‘Too Big Too Fail’ meme, although it alone was not enough to do that, as it lacked some teeth. But it opened the door to a debate that is not occurring.

What exactly is the role of the financial system, and what needs to be done to regulate it, and help it to perform some utility to society's greater functions? Is the relationship between the financial sector and the productive economy out of balance?

I want to stress this. Any proposal that has not been hammered upon by multiple minds, and tempered with the objections and observations of many perspectives, is likely to be premature, needing much work. By its method of introduction, I fear that the reconsideration of the relationship between the FIRE sector and the productive economy is now off the table.

People seem to be making assumptions about what the Volcker Rule would and would not include. For example, there is reference to the 'shadow banking system' that is something relatively new, the intersection of investment banking and mortgage origination. Does anyone really believe that Volcker would object if mortgage origination and similar long term loans were relegated to the commercial banks and the GSE's? I think not.

For me, the 800 pound gorilla is who obtains access to the discount window and Treasury guarantee programs, and who can be a primary dealer for the Fed. I would say that a company that is not a bank cannot. It is as simple as that. And this is what Wall Street hates so much about anything like Glass-Steagall or the Volcker Rule. They want to be able to tap the Fed's balance sheet, and still maintain their aggressive leverage.

There is a reason that the banks engaged in a decades long effort, costing hundreds of millions in lobbying payments of various sorts, to overturn Glass-Steagall. To ignore that reality is to fall into the trap of the financial engineering distortion that is crippling the Western world. The bankers wanted to broaden their portfolio to intertwine their higher risk efforts with the public trust, as insurance against the occasional setback to even the best laid plans.

Relatively simple systems are more resilient and robust; needlessly complex systems are doomed to increase in complexity to the point of failure without accomplishing anything except more complexity.

The trade offs are always there, and a good system contains a mix of both.

Perhaps the new ‘reform legislation’ will be effective, but I doubt it quite a bit almost to the point of certainty. It will be hailed as an 'evolutionary effort' but will contain loopholes large enough to drive a CEO's bonus through. . If it does nothing to separate self interested, higher risk speculation from the trough of the Fed's balance sheet, it will institutionalize moral hazard, which has probably been the goal of the banks all along.

If the reform legislation relies on firms erecting 'chinese walls' within their firms, and regulators being able to sort out various types of regulated and unregulated activity within a firm, then it is my opinion that it is anathema to sound financial management, and doomed to failure. The problem is fraud, and deception, and regulatory capture. The rules must be as clear, simple, and difficult to cheat as is possible.

And then we will see the return of the financial pundits, suggesting this tweak, and that tweak, this addition to close that loophole, and if only we had made this change. Its a good game really, because it ensure a steady flow of funds from the bank lobby to the Congress, and full employment for financial engineers who can engage in endless argument about the relative merits of the latest tweak.

And the zombie banks will continue to drain the life from the real economy, not in dramatic bailouts, but in a steady stream of slow debilitation. But they will be able to pay enormous salaries and bonuses to their captains and lieutenants, by gaming nearly every financial instrument and market in the world.

This is what will doom the West to a stagflation that will mimic the long Japanese decline, their lost decades. It may not ultimately be resolved without social disorder.

The people are still too easily lulled by jargon and reassurance, and the econorati still believe in financial engineering. If only we put a clever tweak here, and an easy rule change there, things will be fine again. That is why allowing engineers to fix their own 'big system' problems is almost always doomed to failure, because they are too intellectually fascinated with their own creation, and cannot see it in the stark light of objectivity and its function as part of the whole.

How will we fix this? How will we accomplish that? Well, perhaps one can look at how those functions were addressed before the system started to go off kilter, say around 1990, and find an answer there. But that drives the financial engineering crew batty, because it sounds antithetical to Progress. It might stifle innovation.

Well, one might as well say that if they stop getting drunk and engaging in random sex, they will also not wake up next to so many new and interesting people. The point is, you do not have to engage in high risk behaviour to accomplish personal and institutional growth. And there is a role for stifling some things, so that only the good can thrive. It is a basic principle of what used to be called conservatism before it was co-opted by the neo-cons. We have to keep first principles in mind even as we change the specifics.

Was the real economy served better by subprime mortgage collateralization and the growth of an unregulated shadow banking system? Ask the average person, and the answer is clear. But the question is never put that way. To a financial engineer, it is the system itself that matters, and not its primary application, to serve the real economy.

The objective of reform would ideally be more than merely preventing the next collapse of the same sort. It would involve giving the middle class a fighting chance to recover itself and prosper again. And that would involve shrinking the portfolio of the Wall Street banks, and expanding the function and stability or regional and local banking. Already the elite are softening up that hope, of a middle class recovery, by forecasting years of underemployment and decline as an inevitability.

The title of this blog does not refer to the Volcker Rule, which was dead out of the gate by its method of introduction into the process, late and fleshless, and quite possibly by intent to stifle debate. It refers to the public, the poor horses that will be beaten senseless by the FIRE sector over the next ten years for their diversion and entertainment. Am I wrong?

So time to move on, to assess what will be coming out of Washington by way of reform. But I have little hope that there will be anything in it that does not serve about ten corporate institutions well, and a financial elite, to the disadvantage of the rest of the world in the form of distorted markets, institutionalized fraud, and the seignorage of the currency reserves.

Would that I am wrong, I doubt it very, very much.

CFR: When the Fed Stops Monetizing US Sovereign Debt...

The people at the Council on Foreign Relations speculate that US interest rates on Treasury debt will be increasing around the end of the first quarter if the Fed discountinues its monetization of mortgage debt.

As the Fed has essentially purchased ALL new US Treasury issuance since 2009, that seems to be a reasonable bet.

"The Federal Reserve plans to stop buying securities issued by government housing loan agencies Fannie Mae and Freddie Mac by the end of the first quarter.

This is not only likely to push up mortgage rates; Treasury rates should rise as well. Throughout 2009, the private sector sold a portion of their agency holdings to the Fed and used those funds to buy Treasurys.

Once the Fed’s agency purchases stop, this private sector portfolio shift will end, removing a major source of demand in the Treasury market.

As the chart shows, since the start of 2009 the Fed has bought or financed the entire increase in Treasury issuance. As Fed purchases slow and Treasury issuance continues at a high level, interest rates will have to move up to attract new buyers."

Non Farm Payrolls Benchmark Revision and the Unemployment Rate as Cruel Farce

Well, we forecast the headline number exactly, with a loss of 20,000 jobs. No credit taken, it was as much a judgement call (aka SWAG) as any product of careful measurement.

As you may have heard, the Bureau of Labor Statistics did a benchmark revision. This is Washington speak for 'revised the numbers as far back as anyone might care to remember to give ourselves more wiggle room.'

The benchmark is a product of the Bernays Factor, that measure of public gullibility which permits obviously contrived government statistics to be taken seriously.

Did you react to the positive jobs trend initially announced in September - October 2009? Oops, it was really a greater loss than expected, and not a gain at all. One can only suspect that in a few years this whole recovery could be revised away without so much as a bureaucratic blush.

Here is a picture comparing the old and new headline numbers.



The change is pervasive. One item of note is the taking of more job losses in the earlier years, setting up a stable base for potential job gains in the present, without embarrassing oneself by getting out of synchronization with the actual growth of the civilian population. There will be more 'truing up' of the numbers in the future.


Unemployment Rate as Cruel Farce

Regarding that 'surprise drop' in unemployment to 9.7%, this is the result of people falling off the unemployment benefits radar, and becoming discouraged. It is essentially meaningless, if not downright misleading.

One may as well solve an unemployment problem by shipping people to Australia. Well, that does have some historical precedent. Hard to tell who has gotten the better deal on that one, at least over the long run.

A better measure of unemployment is the Labor Force Participation Rate, which provides information about the total number of people employed as a percent of the population, without benefit of official banishment.



That number continued its downtrend from 64.9% in November to 64.7% in January, with a slight uptick from December's low of 64.6%.

Here is a chart from the good folks at Calculated Risk that shows the employment situation in context with other post World War II recessions.



"Recession" hardly does it justice, does it?

Proprietary Trading and Credit Default Swaps - Mission (Not) Accomplished

Here's why the Volcker Rule ran into a brick wall of Senatorial gravitas and pusillanimous punditry.

Give up prop trading AND banking status? The mutant Zombie Banks would not allow it.

Who needs insured deposits? What a bother. Its the Treasury guaranteed bonds and Discount Window access that count. When you are levering up Other People's Money you want it in bulk and wholesale, not retail.

Goldman is no surprise, because they are nothing but a hedge fund with the right connections and a rolodex full of Senators. But JPM bears watching, since they are at least nominally a bank, and Too Big Not To Leave a Mark (TBNTLM).

Prop trading - why lend when you can play at the tables?



Well, at least we have the Credit Default Swaps situation covered with the bailout of AIG, right?

Well, maybe not.... Two trillion down, but thirteen trillion to go.

I can see why the Fed completely failed to notice this little trend change in its banking oversight.



If the markets turn significantly lower, and the banks' balance sheets start wobbling again, and threaten to crash the system, or else, perhaps Obama can send young Tim up to the Congress with another scribbled request for a trillion dollar bailout. I can hear the sound of knives being drawn as he walks in the door...