You might think after the disastrous debut of HealthCare.gov and thousands of insurance cancellations, those who call themselves progressives might just have a little humility about grandiose government schemes with vague terms and objectives.
Not so, at least according to the adulatory greeting by liberal activists and the establishment media of this month’s implementation of a pie-in-the-sky provision of the Dodd-Frank financial “reform,” a law that has often been referred to by experts as the financial equivalent of Obamacare for Main Street banks and their customers
Like Obamacare, Dodd-Frank was a 2,500-plus page law rammed through the Democrat-controlled Congress in 2010. And like the bureaucrat-written rules implementing Obamacare, the regulations implementing the law are pretty lengthy as well.
Joint regulations issued last week to implement Dodd-Frank’s so-called Volcker Rule were almost 1,000 pages, nearly half as long as the law itself. “Changing the Ways of Wall Street” was how a New York Times news piece characterized the rule when it was released last week.
Yet this week, even the NYT was compelled to report on the regulation hitting a bank that was about as far away from Wall Street as once could get. “Volcker Rule Quickly Hits Utah Bank,” reads the headline of an NYT article describing how the Volcker Rule forced Salt Lake City-based Zions Bancorporation to divest a long-held debt security and take a loss of $387 million by doing so.
As Bloomberg notes in its piece on the shocking hit to the bank’s balance sheet, this “cost is more than Zions earned for any calendar year since 2007.” And Zions isn’t the only bank far away from Wall Street feeling the impact of this rule. The head of the Independent Community Bankers of America told Bloomberg Businessweek that more than 300 community banks “are highly likely to take losses in their capital accounts” by New Year’s Day.
In the meantime, the new rules could also reduce sharply the stream of initial public offerings that have been propelling the stock-market upsurge. Just as regulatory impediments to smaller IPOs were relaxed modestly with the bipartisan Jumpstart Our Business Startups (JOBS) Act signed by President Obama last year, the Volcker rule will likely erect new barriers to market making by Main Street banks underwriting the offerings of these smaller firms.
Even as written in the Dodd-Frank financial “reform” statute, the Volcker Rule was a solution in search of a problem, or in search of a factor that was not even a minor cause of the financial crisis. The provision, often referred to a “Glass-Steagall lite” – after the 1930s law that was repealed by President Clinton in 1999 – maintains Glass-Steagall’s false dichotomy of inherently “risky” trading vs. inherently “safe” lending.
And it doesn’t ban or restrict trading based on level of risk, but on whether the trading is ”proprietary.” Most discouragingly, in the statute and in last week’s edict, the Volcker Rule contains explicit exemptions for trading in risky government-backed securities, such as municipal bonds and foreign sovereign debt.
There is no evidence that proprietary trading — a bank trading for its own portfolio — is more dangerous than executing trades for customers. In the leadup to the financial crisis, banks traded mortgage-backed securities for themselves and for their customers, but at bottom the instruments were dangerous due to the underlying mortgage loans — loans encouraged by governmental entities such as Fannie Mae and Freddie Mac and by mandates such as the Community Reinvestment Act (CRA). A comprehensive study published last year by the National Bureau of Economic Research concludes that the CRA led banks to make loans that were “markedly riskier.”
Even the Volcker Rule’s architect, former Federal Reserve Chairman Paul Volcker, concedes that banks must do some incidental trading for their own portfolios to carry out other functions. This type of trading includes buying shares to “make markets” for companies they take public and to hedge the risk of ordinary loans such as mortgages.
But in practice, it’s very difficult to tell which type of trading is “proprietary.” As former Sen. Ted Kaufman, D-Del., who (wrongly) advocates bringing back Glass-Steagall, wrote in Forbes just after the rules were released, “Who’s to know what’s a hedge, what’s market making (trading on behalf of clients), and what’s trading for the bank’s own account? The paper trails can be inconclusive. Like angels on pins, there is never going to be an answer.”
And IPOs, particularly for smaller companies, are likely to take a hit. In order to underwrite a stock market offering, banks have to engage in “market making.” They “make” a liquid market for the stock by buying shares in the company to generate demand. But the new rule, according to various interpretations (that will be further revised as the new language is examined), puts many new burdens on this traditional practice.
According to the Wall Street Journal, “the rule … will require banks to provide ‘demonstrable analysis of historical customer demand’ for financial assets they buy and sell on behalf of clients.” But how does a bank show “historical customer demand” for a company that has never gone public before?!
This could have the biggest impact on smaller IPOs, in which banks can’t easily measure “historical demand” and would likely have to buy more shares to create more demand than they would for a larger firm. Some banks may look at the compliance costs and simply not underwrite smaller IPOs, harming innovation by entrepreneurs and wealth-building by ordinary investors.
This could also slow the growth of IPOs underwritten by non-Wall Street banks. In recent years, and since the modest regulatory relief from some Dodd-Frank and Sarbanes-Oxley provisions from the JOBS Act, regional banks such as Atlanta-based SunTrust and Cleveland-based Key Bank have increased their sponsorship of new companies going public.
And in further showing that the Volcker Rule and its implementation is not focused on preventing risk, the new rules contain explicit and blanket trading exemptions for municipal bonds and foreign-based sovereign debt. And exemptions for banks to buy and sell securities in Fannie and Freddie, the two proximate causes of the crisis, were already in the Dodd-Frank statute.
This creates the most perverse set of incentives imaginable for financial management. A bank can speculate at will on the debt of risky governments from Greece to Detroit. Yet if it helps a job-creating new business go public, its ability to reap profit by retaining shares would be limited severely.
Mike Konczal, fellow at the progressive Roosevelt Institute think tank, concedes in the Washington Post that “there are real questions and gray areas” in the Volcker Rule, but argues “what’s not to like” in “rebuilding the core banking sector to be boring.”
Here’s another idea. How about dismantling statist policies like Obamacare and the Volcker Rule to rebuild government to be boring? For as the folks of Utah and other places far from Wall Street can once again attest, it is big government that is the biggest threat to financial stability.
John Berlau is senior fellow for finance and access to capital at the Competitive Enterprise Institute.