New Volcker Rule is a bonanza for lawyers
The Washington Post, December 11, 2013
The Volcker Rule, meant to end risky proprietary trading at deposit-taking, taxpayer- protected banks, weighed in upon approval Tuesday at around 1,000 pages (thanks to nearly 900 pages of guidance on how to comply with the 71-page rule). The law firm Jones Day said it had 200 lawyers (!) waiting to pour over this tome once it was released. If the top 50 law firms serving big banks have 100 lawyers on average doing the same thing at $400 an hour, we're talking about $2 million in legal fees per hour, or at least $100 million in the first week alone that banks will invest in the quest for loopholes.
In other words, while it remains to be seen whether the Volcker Rule makes banking any safer, it's clear that another full-employment act for lawyers has been born.
I'm not sure this is the jobs bill America was hoping for.
Now, I'm a lapsed lawyer myself. Some of my best friends are lawyers. (Come to think of it, both of my wives have been lawyers, too. Maybe I need to get out more.) But what's happened with the Volcker Rule—in which a well-intentioned goal gets swallowed up in an ocean of seemingly impenetrable complexity—is emblematic of what ails U.S. governance.
To see why, consider an alternative to Washington's latest bonanza for lawyers and lobbyists. It would be a different Volcker Rule consisting of a simple sentence: "Banks shall hold equity capital equal to at least 20 percent of their total assets." Up from 5 or so percent today, depending on how you count. Maybe you'd need a few pages to make it 20 percent of "risk-adjusted" assets to account for the relative safety of certain holdings.
Presto! The banks have enough capital to withstand any and all losses. Taxpayers are protected. The legal carnival is shut down.
The problem Volcker and his namesake rule seek to address is real. Megabanks whose failure poses risks for the entire economy—and whose deposits are backed by taxpayers—shouldn't be allowed to operate like speculative casinos. Unfortunately, the banking system is actually more concentrated now than it was before the 2008 meltdown. There are two ways to avoid the "too big to fail" threat that still exists.
The first is to limit the risks these big banks take—though regulators don't have a great track record of getting this right. Still, that's the idea behind the Volcker Rule. The trouble is that once you say banks can do some forms of trading that look like "speculation" but not other kinds, it gets complicated fast.
Regulators obviously can't be mind readers divining whether a trader really intends to hedge a bank's position elsewhere or is just making a big bet on behalf of the house. Likewise, it's hard to distinguish between a bank that's providing "liquidity" (by making a market in a security so that it's available should a client need it) from a banker gambling on the direction of prices in a sector generally.
The Volcker Rule tries to sort this out—but Wall Street's phalanxes of lawyers will surely be able to breathe more ambiguity into the deep vagueness the text already seems to contain. For example, major banks will now have to show that any hedges are closely correlated with positions they hold. This apparently means that the bank's "correlation analysis demonstrates that the hedging activity demonstrably reduces or otherwise significantly mitigates the specific, identifiable risks" being hedged.
That little mouthful represents hundreds of millions of dollars in compliance and reporting costs. Not to mention potential litigation or regulatory review involving talmudic Clintonian parsings of what the meaning of the words "demonstrably," "significantly," or "mitigates" is.
And that's just the start of the questions. How long after the fact will such audits or challenges occur? What's more, if these rules will be enforced by regulators who may want to get hired into lucrative jobs by the banks they're supervising, can we be confident the tough calls will be resolved in the public interest?
Given these complexities and incentives, the most important thing we can do—the second way to fix the "too big to fail" problem—is to make sure big banks have enough capital to absorb any conceivable losses. The $6 billion "London whale" loss at JP Morgan Chase is often cited as an example of what the new rule is meant to prevent. But the whale's loss never became a taxpayer problem because JPMorgan had more than enough capital to take the hit.
Paul O'Neill, the former George W. Bush Treasury secretary, told me not long ago that his advice to GOP senators seeking a fix was to lift capital requirements to 20 percent and scrap every other rule entirely. With enough capital, taxpayers are insulated. Everything else is an issue for shareholders. That's capitalism! (O'Neill was told, "You're right—but we can't make the politics work.")
One wit quipped during the last crisis that "Every generation of Americans gets it chance to bail out Citigroup." We can cross our fingers, but I'd feel better about burying that grim axiom if we went heavier on the capital requirements and lighter on the micromanagement.