Streetwise Professor

January 28, 2010

John Gapper Gets It . . . But Doesn’t Really

Filed under: Economics,Financial crisis,Politics — The Professor @ 9:54 pm

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?

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  1. It is puzzling to see JP Morgan buying Sempra after the Volcker rule.

    So what’s the catch?

    Comment by Surya — January 29, 2010 @ 12:48 am

  2. What I don’t understand is why the government doesn’t simply tax bank assets above a certain thershold?

    Taxing bank assets above a set threshold that is below the “TBTF” limit would effectively cap the size of any bank by eliminating the profits on expansion of assets above the desired limit. Banks approaching the desired limit would be forced to sell less profitable assets in order to assume additional assets and smaller banks would be able to compete with large banks that were approaching or at the asset limit.

    At the end of the day, taxing assets above a set threshold would incentivize large banks to maximize asset returns, would allow for the formation of additional banks and would spread credit across a larger and more diversified capital base. Once an asset limit was established, the government could then set risk weighted capital limits. An asset tax would address the “Too Big” aspect of the problem, enforced risk weighted capital requirements would address the probability of failure of any institution. The last part of the equation would be to acutally build a regulatory structure that could audit and examine financial institutions and enforce regulatory requirements.

    Why is this not obvious?

    Comment by Charles — January 29, 2010 @ 10:20 am

  3. Charles–“thershold”: multitasking? LOL. Just kidding you. (Thanks for pointing out the error on the Barone post–I fixed it.)

    One thought: institutions that are actually modest in size can be systemically important. Lehman and Bear were actually relatively small, compared to Goldman and MOST, and to BAC, Citi, Wachovia, JPM-C. Also, assets may be poor metric. An outsized derivatives portfolio can (a) contribute to systemic risk, (b) represent a substantial risk exposure, and (c) lead to risks that don’t show up on the balance sheet in the same way as a big loan portfolio, for instance. You’d really need to make sure the risk is price appropriately.

    The ProfessorComment by The Professor — January 29, 2010 @ 2:27 pm

  4. Ahh…JPM has backed down from buying Sempra’s north american power trading operations. Looks like folks are taking the Volcker proposals seriously.

    Comment by Surya — January 31, 2010 @ 12:20 am

  5. Surya–Have a cite re JPM-C/Sempra? Are they spinning off the power trading ops?

    The ProfessorComment by The Professor — January 31, 2010 @ 8:16 am

  6. Spark spread has been reporting on this. I guess Blythe Masters of JPM really wanted the deal done – but Bama-Volcker put an end to it.

    J.P. Morgan has dropped its approximately $4 billion bid for the whole of RBS Sempra Commodities and is instead looking to acquire the JV’s businesses outside North America, SparkSpread has learned.

    Under one scenario being discussed, Sempra Energy would buy back Royal Bank of Scotland’s 51% stake in RBS Sempra Commodities’ North American business, and J.P. Morgan would acquire the JV’s European trading operation, according to two industry sources.

    J.P. Morgan is also interested in acquiring RBS Sempra’s North American oil trading business, says one source.

    The financial terms of the revised bid could not be determined.

    Spokesmen for Sempra, RBS and J.P. Morgan did not immediately respond to e-mails.

    The moves come as Kaushik Amin, ceo of RBS Sempra, resigned earlier today.

    He has been replaced by Mike Beck, global head of oil trading; and Michael Goldstein, general counsel, who were named earlier today as co-chief executives, with immediate effect.

    Comment by Surya — January 31, 2010 @ 9:30 am

  7. Very interesting, Surya. Thanks. Actually, Kaushik is a former colleague of mine at the University of Michigan Business School. We had been talking about me doing some stuff with Lehman’s commodity business, oh, in July-August, 2008. For some reason, those discussions ended. Wonder why? Wonder what the full story re his departure from RBS-Sempra.

    It is interesting. He was an options pricing guy, then an interest rate modeling guy, and now commodities.

    The ProfessorComment by The Professor — January 31, 2010 @ 12:18 pm

  8. You might find this interesting too as to why things slowed down post Aug 2008.

    I think he was asked to head Sempra after the founders Messer & Gallipoli left due to RBS going belly up. I could have understood his departure had JPM acquired RBS-Sempra’s north american operations in full. Looks like he was Jarrow’s student.

    Comment by Surya — January 31, 2010 @ 1:29 pm

  9. Thanks again, S. What you sent doesn’t really surprise me. Yes, he was Jarrow’s student in the late-80s. Followed Andy Morton (of Heath-Jarrow-Morton) to Wall Street in the mid-90s.

    The ProfessorComment by The Professor — January 31, 2010 @ 7:43 pm

  10. No wonder he got into interest rate modeling. Looks like Morton eventually ended up as head of the LEH fixed income division – wonder where he is right now..

    Comment by Surya — February 1, 2010 @ 4:58 am


    He got a $2m parachute on leaving Lehman. Not too bad….but not astronomically big either. But by all accounts Morton and Amin have done very well. I have read (Derman’s book) that Fischer Black despite being an MD at GS, took home the least bonuses. Looks like things have changed … or the PhD guys have learned how to play the game better 😀

    Comment by Surya — February 1, 2010 @ 5:03 am

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