lifestyle leader

In the past week there has been plenty of analysis on the Volcker Rule - largely by people more knowledgeable than myself. Most, it appears, agree with the notion that we need to do something to prevent the capitalist pirates on-board S.S. Too Big To Fail (pictured right) from sailing around and holding the rest of our economic flotilla hostage. Most also seem to agree that this proposed "something" is better than nothing.

Much of this is speculation, however, since we lack the necessary details to make a final judgment - details which will apparently be left to that venerable institution known as the US Congress. If the healthcare bill is anything to go by.... nevermind.

But let's back up a bit. Because while I have made it clear that Volcker's vision sounds - at first glance - to be quite compelling, I am still struggling with some of the key concepts. Well, one key concept actually: too big to fail. Volcker's plans rest on the notion that commercial banking has a privileged place in our financial system. We depend upon our banks for the day-to-day running of the economy, the argument goes, so we cannot allow them to act like hedge funds on the side. Fair enough.

But merely separating the two activities into "can be allowed to fail" and "can't be allowed to fail" doesn't really address the problem. Much of the financial turmoil originated in the shadow banking sector: entities engaged in "bank-like" activities (originating loans, re-packaging and securitizing debt) that did not have the level of regulation that commercial banks do OR any of the deposit insurance that keeps things secure (detailed explanation available here). When things went tits up, investors fled the shadow banking sector for, you guessed it, the heavily insured mainstream banking sector. Presto, credit crunch.

So again, the question comes down to how splitting apart the riskiest behaviour of our banks is going to prevent a future crisis of this nature. Poor banking regulation was certainly a problem, but so was the fact that a huge financial industry was created outside the regulatory system. It had no safety valve, no backup whatsoever. Volcker's plan does not appear to address this. If anything, it might make this line of business more profitable.

How can we be so sure that only deposit-taking institutions are systemically important (re: too-big-to-fail) enough to protect? The answer is that we can't. Maybe I've been listening to the top financial regulator in my country too much, but it seems the very act of identifying too-big-to-fail creates its own problems.

So I guess my concern with the Volcker Rule is not what it is proposing for deposit-taking institutions, but what it is not proposing for everyone else.

(Update: the top central bankers in both the UK and EU have vocalized their (qualified) support for the reform proposals - good to see the old boys network holding firm, eh whot?)