Wednesday, February 15, 2012

It's Still About Leverage

FLG has written several times about how almost as soon as FLG begins to think Felix Salmon might just be a somewhat insightful journalist, he ruins it by posting something eyebleedingly dumb. Case in point, his insistence that the Occupy the SEC letter on the Volker Rule is amazing.

For those of you not paying attention to all this, the Volker Rule is a portion of the Dodd-Frank bill that attempts to restrict banks from engaging in proprietary trading, .i.e. the banks speculating in the market. As FLG has said before, he's generally supportive of the principle. He worries that the complexity of trying to implement it in practice will be a complete clusterfuck of complexity.

And, shocker, guess what the Occupy the SEC letter is? A complete clusterfuck of complexity. To be entirely fair, it is pretty damn good at what it is attempting to do. The people who wrote it were clearly in banking and are involved/were involved with this stuff on a day-to-day basis.

But that's part of the problem. There's can't see the forest through the trees. By which FLG means the thing was written from the POV of people in the finance industry trying to think of all the places that problems can arise in the day-to-day activities they perform. There's all these rules about underwriting, about what risks can be hedged with what products. They want, and FLG quotes, "a central database that catalogues the hedges that are consistently appropriate for each product." There's rules trying to prevent trading from simply shifting offshore. You get the idea.

This isn't to say that any of these are a bad idea, but it kind of misses the point. The issue we had in 2008 was systematic risk. Trying to limit systematic risk by trying to micromanage through statue and regulation the day-to-day activities of people who are 1) very smart and 2) stand to make a lot of money by finding loopholes is a dumb strategy.

Better just to deal with bank size and the real problem -- leverage. Less levered, smaller banks are less of a systematic risk. Full stop. Sure, the actual implementation will be more complex than that, but it will be way less complex than trying to stop proprietary trading.

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