Thursday, February 16, 2012

Why Quibble Over the Volcker Rule?

As noted in previous blogs, the implementation of the "Volcker Rule" is long overdue, especially after the repeal of the Glass-Steagall Act which had separated commercial and investment banking. Indeed, this removal of a protective barrier ca. 1999 is what led directly to the financial meltdown of 2008, with regular commercial banks becoming caught up in trillions of unregulated and risky derivatives called "credit default swaps".

What's the big deal here? Basically, that any banks that use taxpayer-provided funds, e.g. via federal deposit insurance, ought not be allowed to place market bets with that money.....lose a bundle of it....then beg for taxpayer bailouts. As noted in the FORTUNE article: 'The $55 TRILLION QUESTION' (October, 2009, p. 135), credit default swaps (CDS) emerged as bets "that: 1) could be struck in a minute, 2) required little or no cash upfront and 3) could cover anything"

Thus did we see counterparty CDS bets wagered between commercial banks that bet $x billions worth of mortgages would fail, or that ten thousand communities would go down the toilet. When many of the bets were lost, the banks left holding the debts became "zombies" often with ten times more liabilities than cash on hand. Hence, the parlous credit freeze, and hence also ...the urgent need for government to supply a stimulus or watch another Great Depression unfold.

In other words, the Volcker rule embodies a common sense goal that banks that ought to be holding our money safely for us and making only secure loans with reasonable probability of being repaid, shouldn't be making reckless Vegas-style casino bets.

Thus, in the "Volcker Rule", the banks either have to make do with no "proprietary trading" (such as in the risky derivatives market) or they will cease to be afforded the protection of the government, including the Federal Reserve - which will entail giving up federal deposit insurance protection, as well as any Federal Reserve bail outs for misguided moves.

As Volcker himself put it, quoted in a 2010 Financial Times piece (Feb 15, 'Goldman Faces Stark Choice on 'Volcker Rule'):

"Don't expect the support you would get from being a bank within the club of insured deposits, and access to the Federal Reserve and all the loving attention you get as a banking organization"

Yet now evidently there are thousands of quibbles over implementing the Volcker rule, to the extent it may well be diluted to the point of near uselessness. Most of these objections arrived at the SEC before Monday's deadline for comments on the proposed rule. At issue: Who gets dinged by the rule and who doesn't? Encapsulating this is the opinion appearing in the article 'No Exception to the Volcker Rule' (WSJ, Feb. 15, p. C14):

"Already some have argued that all, not just some, state and municipal debt, should be exempted. That in turn raises the question of why (U.S.) government debt markets are being favored over corporate ones......some say the rule actually needs to be way to do this: apply the rule equally by eliminating the exemption of U.S. government debt."

Showing, of course,this writer has his head stuck where the Sun doesn't shine. This is evident by his convenient conflation of U.S. government debt (in the selling of government securities, U.S. treasury bonds, etc.) and the selling of local or municipal or state debt, or corporate debt. The reason for this deficit in thought is difficult to parse.

Seemingly, the WSJ author (David Reilly) never heard of the Constitution mandate to address debt as written in Amendment XIV, Section 4, which stipulates:"The validity of the Public Debt of the United States, authorized by law, includes debts incurred for payment of pensions ....and shall not be questioned."

The effect of this is that U.S. government securities must trump all others in value and faith. It is for this reason holders grasp that what they have isn't an empty promise on paper (as we saw in the case of so much municipal and state debt, as well as corporate in the wake of the CDS meltdown) but rather a debt that the holder can count on as being repaid. Thus, as Bloomberg columnist John M. Berry put it three years ago ('The Wrong Solution', Rocky Mountain News, p. 2c, Dec. 5):

"What the bondholder has is the United States' promise to pay -- the government's full faith and credit -- which has always been good. "

Do we have that from the local states and municipalities? Errrr.....NO! If they make incorrect or hubristic investments, say as they did in the CDS derivatives market in 2007-08, holders can lose. Did we have that in the corporate bond (or junk bond )markets? Say in the 80s? I have only two words for you: Michael Millken! Who was he? Creator of the alleged "high yield junk bonds" which left tens of thousands of investors in the lurch, or poor house. Millken proferred a 1990 guilty plea for felony charges, in violating US securities laws.

So do we believe the artifacts known as corporations will hold to the law any better? If anyone does I have a three acre ocean front plot in Barbados to sell you! See, corporations are profit machines, not indemnifying machines. If you lose bucks, too bad. You should have known better. Think a corporation or even bank would ever WILLINGLY offer something along the lines of FDIC protection which most of us take for granted? If you do, I have a ten acre plot off Barbados' west coast for you with a beach house tossed in!

The same WSJ author Reilly observes that Bank Of Canada governor Mark Carney is also whining about the selective application of the Volcker Rule. But can he assure Americans that if they have Canadian securities and something happens, those securities are backed by the full faith and credit of the Canadian goverment like U.S. securities are? I doubt it! He can't extend that assurance because he can't give it, the Canadian laws and regs don't permit it. Nuff said.

The Volcker rule as it must be applied can only exempt U.S. government securities because they have the highest faith and quality value - that's why every Tom, Dick and Harry on the planet is now feverishly buying that debt in order to escape the unsafe places.

One more thing, it is that debt purchase which allows the U.S. government to keep on keeping on, something neither local- municipal, state or corporate debt can do! Want to see your armies overseas continue to get fed, equipped, supplied and be able to carry on? Want to keep receiving your Social Security checks? Want your federal highways, airports to be maintained ....including the latter staffed with enough air traffic controllers? Then you better damned well hope that U.S. securities, bonds, keep getting sold to support those causes ....and not become subject to a Volcker rule as certain financial nimrods try to claim!

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