It Looks Good on You, Though

With the closing of the comment period for the so called "Volcker Rule" ("The Rule"), the public waits to see what, if any, amendments are offered to this Glass-Steagall redux. The Rule prohibits banks (read: institutions whose capital is in part backed by FDIC guarantees) from engaging in proprietary trading (read: trading securities for the purpose of extracting profits).   Removing that sort of moral hazard is something many can agree on.

One common criticism of The Rule is that it bans a legitimate business model in toto rather than subjecting that practice to more stringent risk controls.  As is, it's a tacit admission by federal regulators that they really have no clue how to create and enforce risk controls and therefore, they'll just regulate the complexity right out of the picture.

It's a baby and bathwater thing. 

The public—still smarting from the financial crisis—and the Obama administration—still eager to shift all responsibility for the housing bubble away from Washington's failed policies—are both content to keep beating up on banks, so that objection hasn't gotten very far.

There’s another snag developing.  US government securities would be exempt from The Rule in its current form.  Why?  Well, those things are "risk free" of course!  Now, per the Wall Street Journal, Bank of Canada governor Mark Carney has weighed in saying, in essence, "But ours should be exempt, too!"  He has a point: the Canucks and their Loonies have been models of fiscal sanity compared to their drunken-sailor neighbors to the south.  Other foreign governments and some state and municipal governments may also be exempt, according to the WSJ.

But, as the article points out, why draw the line between governments and corporations?

Liquidity.

If large banks quit trading certain securities for their own accounts, the trading volume of those securities will decline dramatically.  If that should happen, any neophyte student of capital markets will tell you that the price / value relationship of those securities becomes more murky and investors, at the margin, will be less attracted to those instruments.

From the Obama Administration's perspective, a liquidity decline would be just fine for the securities of corporations—big, bad profit centers that they are.  But when you start talking about declining liquidity for Treasurys, well, that's a horse of a different color!

How much harder would it be to monetize the federal debt if the market for those bonds should become less liquid?  DC says simply: "Let's not even go there." 

The double standard reminds one of the scene in Caddyshack where Al Czervik (Rodney Dangerfield) notices "the worst looking hat [he] ever saw", only to realize that Elihu Smails (Ted Knight) is wearing that same plaid eyesore and quickly responds, "Oh, it looks good on you though!"

Washington seems to think that the prop trading restriction is an ugly hat for Treasurys.  But it looks just fine on corporations.