In his article on the Volcker Plan in today’s FT, John Gapper meanders around in an attempt to defend it, and then stumbles on this realization that undermines most of his previous justifications:
There is, however, one substantial objection to the Volcker rule as it has been structured by the administration. [And believe me--it's substantial. Like so substantial as to demolish the case altogether.] It focuses on deposit-taking banks rather than, as Mr Volcker’s G30 report last year phrased it, “systemically important financial institutions”.
This means that it would apply to, for example, JPMorgan and Bank of America, but probably not to Goldman Sachs and Morgan Stanley. These investment banks have the option of giving up their bank holding company status, shedding deposit-taking, and being able to continue combining proprietary and customer businesses.
Leaving aside the strange consequence that an attempt to curb banks could end up helping Goldman by reducing the competition, this is wrong in principle. Even if Goldman and Morgan Stanley surrendered access to the discount window and their bank status, do we really believe this deals with the problem?
Of course not, for we cannot (much as everyone would like to) erase the memory of the last time trouble struck. The Treasury was forced to bail out Goldman and intervene to prop up American International Group, the full details of which are now embarrassing Mr Geithner. [Emphasis added.]
Well, exactly. But immediately after having the lightbulb go on, and figuring out that rules limited to deposit taking banks with access to the discount window will do nothing to prevent a recurrence of a financial crisis, and may actually make one more likely, he lamely sticks up for Volcker:
The Volcker rule is not perfect but is the best attempt yet to confront head on the legacy of that time. If it were extended to Wall Street as a whole, it would be better still.
Just what does “extend[ing] [the rule] to Wall Street as a whole” mean, exactly? No prop trading by anybody? That’s asinine. If he means addressing To Big To Fail more comprehensively, well I agree with that, but it’s hard to figure how a non-asinine extension of the Volcker rule could do it.
Which means that you have to do something different altogether. The Volcker plan is clearly insufficient to address TBTF in a serious way. It seems the creation of a man–sorry to say it–who is past his prime and somewhat nostalgic for a Glass-Steagall world of his prime even though the repeal of Glass-Steagall really had zip to do with fomenting the financial crisis. Volcker clearly has good intentions to tackle TBTF, but good intentions aren’t enough.
Some more imaginative thinking is in order. TBTF is the result of the interaction between two, distinct, entities: financial institutions and the government. All of the noodling has been directed at the former, very little at the latter. TBTF wouldn’t exist if it were possible to make credible government commitments not to bail out. To focus on banks alone is to assert that government is beyond hope. That it has as much ability to make commitments not to indulge in bad habits as your typical methhead.
Maybe that’s true.
Is that what advocates of regulation actually believe? Let them be explicit about it then. Pretty scary thought: we have to trust the government with all sorts of powers over financial institutions because the government is constitutionally (small-c) unable to avoid taking destructive actions involving financial institutions.
Wouldn’t it be worth a little more effort to think of ways to improve the government’s ability to pre-commit, than to basically concede the point and focus all attention on how to keep banks from putting the government in a position where its willpower is tested?
Do we need to call in Dr. Strangelove?