Here Comes Volcker

Yesterday was all about Paul Volcker's Opinion piece in the NY Times.

http://www.nytimes.com/2010/01/31/opinion/31volcker.html?em

Many witty bloggers were disappointed in that even though his op-ed piece was long it was also short on specifics. It just rehashed what he thought of bankers and their pursuits without actually giving us a plan to figure out how to prevent excess and systemic risk.

But he does explain himself when it comes to bankers conflict of interest. That these interest need to be stemmed. Regulation has to be smart not wide spread. Smart regulation needs to be implemented that disincentivize banks from engaging in activities that increase systemic risks and harms the economy. What needs to be done is regulation has to be made on a global basis, so that everyone is on the same page on the same side of the table.

But what Volcker doesn't explain or get to the heart of is that any type of reform not only needs to be global but must change the market structure itself.

http://tradersutra.blogspot.com/2010/01/market-structure-needs-to-change.html

He fails to mention that banks control the credit system. In a network finance world, the banks control the network. They control the infrastructure to which not only the payment system runs but also the credit system, and its the credit system that is essential to a working economy. He is completely ignoring the global banking phenomena. He doesn't explain how we are going to erase the public safety net to which these institutions currently enjoy. For that we need to change the market structure. He talks about reforming banks trading operations but doesn't mention banks OTC Trading operations. For that to happen, the market structure needs to change.

All of the things that Volcker talks about are important and viable, the problem lies in the things he doesn't talk about. Sadly the things he does have an opinion on which makes perfect sense are not politically viable anyway. This is why Financial Reform has been gutted.

Something is missing here. Volcker's tone from the beginning has been of disdain for bankers/traders and their sordid practices that led to the crisis. He has spoken about financial innovation and the dangers of structured products. But he doesn't and hasn't gone far enough.

Why not come out and just say the following:

-Securitization needs to change. Wall Street should have skin in the game. They should be forced to buy and keep on their balance sheet at least 10% of the deals they underwrite.

http://tradersutra.blogspot.com/2009/06/obama-financial-regulatory-plan.html

-A real viable Consumer Protection Agency should be set up with plain vanilla mortgage choices. Everyone should know their options and worst case scenario's before they sign on the bottom line.

-Loan Standards should be strengthened to the point that getting a mortgage should be a lengthy process. This protects both lender and borrower.

-Subprime mortgages should be banned. If you can't conform to Fannie/Freddie/GNMA. go rent till you can.

-Break up the Ratings Agencies. Throw them in the garbage. The investors/institutions/pension plans/mutual funds that actually buy these securities should finance a new ratings agency model. The days of the thief telling the judge to set the ratings should be long over.

-The Repo Market needs to be reformed. I have said that the trick in controlling leverage is controlling the Repo Market. Only the best types of collateral should be used to finance positions. Also Treasuries should not be exempt from the Presidents Bank Tax.

-Ban Naked CDS Selling. This is completely ludicrous and I cant to this day believe this was allowed to go on.

-CDS counter parties should be properly capitalized. They should be as reserved as the insurance companies.

-CDS should be traded on a exchange. This would level the playing field and narrow bid/ask spreads. When the banks figure out that margins are compressing, they will think twice before they start gambling.

All of this is predicated on a changing market structure.

Banking along with investment management and trading has evolved to the point that they are singular in nature. Gathering deposits and then lending against them has become dangerous to the point that they have to be backstopped by the tax payer. There is unfortunately no way back from this. The only thing we can think of is short term plug in ideas that temporarily stem the tide till the next crisis. To truly change the market structure we need 20-30 years of solid ideas and execution. But long term we are all dead and in the interim we need a solution. The solution is of course empty promises, gutted financial reform and back to business as usual.

In the end, the banks have gotten so powerful politically that even someone of Volcker's stature cant really change the industry. That is because maybe Mr. Volcker himself doesn't understand the magnitude of the structural changes that need to be made.

We may just need another crisis to occur.