Poor Bank Examiners!

Dialogue with the Alter Ego on the new Volcker Rule

Question by Alter Ego of Noah denkt™ (AE): In the course of the last few days a new Volcker Rule, i.e. a rule that regulates and limits speculation activities of commercial banks with a more than US$50 billion balance sheet has been adopted in the US. That, in a way, validates one of your earlier predictions, according to which it would be necessary, albeit in due time, to impose a certain degree of restrictions on bank conglomerates. ( See: http://www.noahdenkt.com/noahdenktwvolcker2.html) Does Noah denkt™ feel vindicated by this latest development?

Answer by Noah denkt™ (Nd): As you know, it took us sometime to come around and support a new Volcker rule. Now, that it has happening, we do in deed feel somewhat vindicated. Nevertheless it seems to us as if the new rule has serious defects since it is quite bureaucratic and puts way too much stress on the work of the bank examiners.

AE: Why do you say that?

Nd: Well, under the new statute big banks are now required to have an even more detailed program that documents in writing the compliance procedures which the bank observes in order to be in sync with their own risk exposure limits and the various provisions of the Volcker Rule. For example, a big bank will now have to demonstrate in writing why a certain hedging position is reducing identifiable risk, which other position it is actually hedging and how the risk exposure of that hedge is evolving under the gyrations of the market place.  Now, imagine the poor bank examiner who supposedly has to review not only the existence of such paperwork but also the viability of the arguments presented therein. It seems to us that it is pretty unreasonable to presume that any group of bank examiners could possibly go to that depth of supervision.

AE: Okay, but the main point of the new Volcker rule is that it prohibits banks from proprietary trading, i.e. trading with its own money as opposed to working with its customers’ money. That is a big achievement, isn’t it?

Nd: Certainly, it is, – even though big banks will still have some discretion in deciding whether certain trades are permissible market-making or not.

AE: So why do you worry about petty, little details when the big picture of the new rule is clearly positive?

Nd: First, because it is quite likely that big banks will outsmart their supervisors given the complexity of the new rule. Second, standard wisdom tells us that all this paperwork will be quickly ignored once a new super bubble develops in the financial markets. And third, it continues to be clear to us that the government will eventually come under pressure again to bail-out financial institutions, even if the latter won’t be covered by a Federal deposit insurance guarantee.

AE: You are reverting here to our first Volcker rule-dialogue that emphasized the systemic risk of organizations such as BlackRock and the now defunct Long Term Capital Management?

Nd: Correct.

AE: So you continue to believe that the BlacRocks of this world will be the ultimate beneficiaries of the new Volcker rule?

Nd: Quite likely so.

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