February13,2012OfficeoftheComptrolleroftheCurrency250EStreetSW,MailStop2M3Washington.DC20219Regs.comments@occ.treas.govMs.JenniferJohnsonSecretary,BoardofGovernorsoftheFederalReserveSystem201hStreetandConstitutionAvenue,NWWashington.DC20551Regs.comments@federalreserve.govMr.RobertFeldmanExecutiveSecretary,FederalDepositInsuranceCorporation
0501/
u,
street,
NWWashington,DC20429comments@fdic.govMs.ElizabethM.MurphySecretary.SecuritiesandExchangeCommission100FStreet,NEWashington.DC20549ruleMcomments@sec.govDavid
A.
Stawick,SecretaryoftheCommissionCommodityFuturesTradingCommissionThreeLafayetteCentre,115521stStreet,NW.Washington,DC20581VolckerRule@CFTC.gov
RE:ProposedRuletoImplementProhibitionsandRestrictionsonProprietaryTradingandCertainInterestsin,andRelationshipswith,HedgeFundsandPrivateEquityFunds
DearSirsandMadams:WewriteinresponsetotherequestforpubliccommentontheproposedruletoimplementtheVolckerRule.embodiedinsection13oftheBankHoldingCompanyAct.'
t
FederalRegister.Vol.76,No.215,November7.2011,
pp.
68846-68972.
1
TheVolckerRuleDemandsthattheU.S.FinancialSystemBeRedesignedtoServetheRealEconomyInrecentyears,theAmericanmiddleclassanditseconomyhavebeenthevictimofthreetypesofabusebythefinancialindustry:usury,bailouts,andprolongedtoleranceofdebtoverhangsthatshouldberesolvedtomaketheeconomymorevital.Anyeconomywherefinancialintermediationbecomesdominatedbythesethreeabusescannotsucceedinthelongrun.Ratherthanprovidingtherealeconomywiththeservicesandresourcesitneedstogrow,aneconomywithafinancialindustrydominatedbythethreeabusesbecomesthemasteroftherealeconomy,infactdrainingitofresources.Wehavelongbeenarguingforamorefunctionalsystem',onewhichdoesmoreofwhatafinancialsystemissupposetodo-supportingtherealeconomythatcreatesjobs,increasesproductivity,andraiseslivingstandards-andlessofwhatitshouldnotdo-extractingresourcesfromtheeconomyandreducingwealth.
2
TheVolckerRule,ascraftedbySenatorsJeffMerkleyandCarlLevin,isoneofthemorepotentforcesavailableforachievingpreciselythatgoal:forcingaredesignofthecapitalmarketsactivitiesofourfinancialsystemsothattheysupporttherealeconomyandminimizingtheriskoffuturefinancialcrashes.Inshort,
it
demandssweepingandhealthychangein'thewayournation'slargestfinancialfirmsdobusiness.TheVolckerRulewasdraftedwithaneyetowards-andmustbeconsideredfrom-asystemicviewpoint.Atitsmostbasic,itforcesastrongseparationbetweenhedgefund-likeactivities
that
deployhighriskinsearchofhighreward,anddepositorylendingbanks,whichshouldtakemodestriskstoextendcredittofamilies,smallbusiness,andtherealeconomygenerally.TheconstructoftheVolckerRulestatutemandatesa
fundamentalreconsideration
ofactivitiesintradingaccountsandoff-balancesheetfundsofbankholdingcompanies,thelocioflossesinrecentcrashes,andtheheartofthecomplextradingactivitiesthatservedonlythebonusesofthebankers,puttaxpayersatrisk,anddidnotservetherealeconomy.TheVolckerRuleforces
the
simplificationofandreductionofthetradingaccountandoff-balancesheetstructures,ensuringthatthoseactivitiesarenotembeddingabusive,dangerousactivities,butarecontainedintheirriskprofileandserveclientneeds.WehaveexaminedthethrustoftheargumentsofthosearguingagainsttheprinciplesoftheVolckerRule,andwefindthemunpersuaslve,self-serving,andtoalargeextent,refutedbywhathashappenedinrecentyears.Inparticular,somehavearguedthattheVolckerRuleapproachistoocomplexandwilllimitliquidity.Theseargumentsareadistraction.TheVolckerRule
will
reducetradingbybanksandquitelikelytradingoverall.Butquitefrankly,thisispreciselywhattherealeconomyneeds.Forinstance,theso-calledliquidityfromflashtrading
2
See
JOSEPHSTIGLITZ,FREE
FALL:AMERICA,
FREEMARKETS,AND
THE
SINKING
OFTHEWORLDECONOMY
(2010);RobertJohnson,
Introduction:MakeMarketsBeMarkets,
inRobertJohnson,EricaPayne,eds,
MAKEMARKETSBEMARKETS,ROOSEVELTINSTITUTE
(2010)
2
disappearedpreciselywhenitwasneededmost.Recentscholarshiphasshownthatthecurrentfinancialsystem,withitsdramaticincreaseintrading,isactuallylessefficientthanthatof1950oreven1980.
3
TradinghasbroughtrecordcompensationforWallStreettraders,buttherealeconomyofthelastthirtyyearshasnotbeensimilarlyinvigorated.Rather,ithasseenrealwagesdecline,jobsmoveoverseas,andthemiddleclassshrink.Tradingvolumeshouldnotbemistakenforefficientcapitalmarketsorproductiveinvestments.TotheextenttheVolckerRuleistoocomplex,thatisatbestareflectionoftheincrediblecomplexitythatbankingitselfhascreated,andatworstareflectionoftheproposedrule'stimidity:itattemptstoprotectthecomplexityofthestatusquoandimplementalawthatdirectsareductionoftradingbybankswith'outreducingtradingbybanksortradingoverall.Thesecontradictionsmustberejected.FortheU.S.torebuildahealthyfinancialsystem-onewheresavingsgotoproductiveinvestments,andthereturnsgobacktheinvestors-theVolckerRule'smandatetoreducebankinvolvementincomplextradingactivitiesmustbeimplemented.Naturally,banksareresistanttothesedemandsbecausetheyhavetakenrefugeincomplexitytoextractmassivemarginsandfeesthatgeneratebonuses,whileavoldingtheharshsunlightofcompetitionandtherisk-reducingincentivesofthethreatoffailure.Ashorthistorylessonwillmakethisclear.Decimalizationofbrokeragecommissionsinthe1990's'cutintobrokerageprofits,whiletheriseofderivativesandcomplexinstrumentsunderminedprofitsfromtransparentmarkets.ThefallofGlass-Steagallandthederegulationofderivativesmeantsecuritiesfirmshadtocompeteagainstbankingfirms,whichhadtheabilitytodeploylargebalancesheetsanddid.Atthesametime,hedgefundslikeLong-TermCapitalManagement(LTCM)provedtheimmenseprofitabilityofcomplextradingstrategies.atleastduringcalmyears.Asthesetrendscametogether,thebankingandsecuritiesindustries-inmanycases,~oweffectivelyone-soughtoutcomplexity,opacity,andleverageasameanstoavoidtruecompetitionandprotectprofitability,andasawaytoextractoutsizeprofitsduringnormalyears,stuffingriskintoeverlarger"fattails."Injustafewyears,thefinanceindustryreplacedclient-serviceandtheextensionofliquidityandcreditwithleveragedproprietarypositionsincomplexalgorithmictradingstrategiesandcomplexstructuredproducts.Thissearchfor"alpha"profitsdroveboomsandbustsandreducedreturnstoinvestors,incrementallyinthenormalyearsandspectacularlyinthebustyears.Inthenormalyears,everydollarmadewhenaproprietarytradingoperationfront-runsacustomerorderorotherwisesurfsonthewavesoftheordersgeneratedbytheircustomerswasadollarlosttopensioners,mutualfunds,andothersaversandinvestors.Andinthebustyears,onlythefirmspluggedintothebailoutwindowscouldavoidthemassivelossesinflictedoneveryoneelse.Complexityprotectsthepowerful,whileeveryoneelseisleftinthedust.Ageneralprincipalofallbusinessesisthattheywouldliketobesubsidizedbythepublic;andageneralprincipleofeconomicsisthatsuchsubsidiesdistortthemarketplace.Anyriskofagovernmentbailout,hiddenortransparent,isasubsidy,andthesesubsidieshavebeendeeply.
3
ThomasPhllippan,
HastheU.S.FinanceIndustryBecomeLessEfficient?,
WorkingPaper,Nov.2011.
3
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