THE VOLCKER REVAMP WAS A SMALL VICTORY IN A WIDER WAR / THE FINANCIAL TIMES OP EDITORIAL

The Volcker revamp was a small victory in a wider war

If banks are intent on getting back to the old days, they need to start somewhere

Robert Armstrong


Traders on the floor of the New York Stock Exchange © AP


When the updated version of the Volcker rule landed last week, all of Wall Street had something to say about it. Among bankers, investors, lobbyists, lawyers and analysts, there were normal differences of opinion. But it was striking that various natural allies of the banks took views that were, at least on some level, logically inconsistent with arguments they have for years made about the burdens imposed by the rule.

Publicly, the banks stayed largely mum: they know there is little to be gained from rejoicing at deregulation. But their institutional views are clear. The Volcker rule was designed to prevent banks that enjoy Federal guarantees from gambling with depositors’ money. It said banks were allowed to trade on behalf of clients or “make markets”. Gambling with the bank’s money, known as “prop trading”, was out.

The banks objected that it is often impossible to tell the two apart, as evidenced by the fact that the rule had to refer to traders’ intentions to distinguish them. Jamie Dimon, boss at JPMorgan Chase, summed it up: for “every trader, we are going to have to have a lawyer, a compliance officer, a doctor to see what their testosterone levels are, and a shrink, [to ask] ‘what is your intent?’.”

The result of all this ambiguity, banks have long warned, is less trading, less liquid markets and higher volatility.

The amended rule effectively shifts the burden of proof regarding intent away from banks and on to bank supervisors, cutting banks’ requirements to keep records and to file reports. The core premise — that banks are assumed to be prop trading unless they can show they are not — has been overturned.

Bank lobbyists celebrated on behalf of their clients. The Bank Policy Institute, run by a former top lawyer at JPMorgan and Bank of America, noted the “damage the original rule has done to responsible banking activity and legitimate market making activity, and the massive and needless compliance costs it imposed”.

Wall Street lawyers agree. The law was hellacious to comply with and probably did very little to discourage risk taking, they said, over and above what tougher capital requirements and regular stress testing were doing anyway. Good riddance.

Analysts and investors also praised the watering down of Volcker — in principle, at least. But in economic terms (the terms Wall Street cares about) their view was sharply different. On bottom lines, they insisted, the change to Volcker would make little difference.

Analysts saluted a change that means banks’ trading operations can rid themselves of heavy compliance-related costs — but they have not upgraded revenue or profit forecasts in response. (Then again, an analyst in the employ of an investment bank might not feel comfortable contravening their employers’ view that the fight over Volcker is about healthy markets, not profit).

Investors were equally unmoved. Bank stocks sustained their longstanding, meandering movements this week, as if nothing much had happened.

So there you have it: the Volcker rule imposed terrible burdens on banks while clogging up the business of trading. But a big reduction in the stringency of the rule will not matter much to bank profits.

This may be a bit less paradoxical than it looks, however. The post-crisis capital requirements and the Volcker rule overlap in the way they discourage risky trades. The former makes the risks unprofitable, the second prohibits them. Removing just one of the regulations — the one that is harder to enforce — naturally does not make a big difference.

But, if the banks are, in fact, intent on getting back to the old swashbuckling days, they need to start somewhere. They may see their victory on Volcker as the first battle in a larger war.

The post-crisis rules are not the only reason that banks behave differently today. The Lehman era diminished investors’ appetites for businesses that take market risk. Look at how bank stocks now trade: Even with low interest rates pressing profits, investors will pay premiums for well-run, boring, take-deposits-and-lend-money banks.

Meanwhile, firms more sensitive to market action, like Goldman Sachs or Jefferies, are trading not far off historically low valuations, on a price/book value basis. The amendment to Volcker makes little immediate impact because the stuff it prohibits just does not pay like it once did.

Or rather, it does not pay right now. It may not be long before bank bosses once again fancy themselves smarter than the markets, and investors are again ready to play along. The key question is what the regulatory regime looks like then, not now.

Volcker has lost its punch. Now the fight moves on to capital rules, liquidity requirements, stress tests and the rest. Each round may look like a squabble over details. But that should not obscure how much is at stake.