Sadly, they have been almost completely victorious. :(
The drama of financial regulatory reform is, to a considerable degree, playing right into the industry’s hands.
(snip)
So the result is that we’ve had proposals come in late in the game that are crowd-pleasing but either ineffective or ill thought out, and that works to the industry’s benefit (they can beat them back, and the existence of a flawed proposal that is taking up legislative and press bandwidth makes it harder for other, better conceived measures to move forward).
One example of the ineffective sort is the so-called Volcker rule, to require depositaries to exit the proprietary trading business. On paper, this is a good idea, but the initial Volcker definition was to distinguish trades executed with end customer versus those that were not, which is not a helpful distinction (bond king Salomon Brothers did a tremendous amount of speculation in its regular trading books, long before there were separate prop desks). Although the language is still in play, banking expert Josh Rosner has said, via e-mail, “the Volker rule has holes large enough to drive 4 Mack Trucks through, side by side.”
By contrast, Blanche Lincoln’s proposal, to force banks to get out of the derivatives business (and the climbdown, to have those businesses separately capitalized), is misguided. The problem here is she and the media have fallen for a master stroke by the industry, that of lumping in credit default swaps with “derivatives”. CDS are highly problematic; they have almost no legitimate uses and come with considerable costs (hugely bad incentives). Moreover, the plans underway will not tame them much. They cannot be margined adequately on a contract by contract basis (any sufficient provision for jump to default risk would render the contract uneconomic and kill the product, which is an unacceptable outcome, so it will continue to be inadequately margined). The best remedy would be to regulate it like insurance (which is what it is) but no one is willing to change directions now.
Plain vanilla swaps, like simple interest rate and foreign exchange swaps are not problematic and customer pricing is pretty transparent. And the banks themselves use these products in large volumes to hedge their own exposures. The flaw in the Lincoln plan is that any derivative business running on an independently financed balance sheet would be unlikely to be large enough to handle the hedging needs of the banks themselves.
Via e-mail, Josh Rosner supplied a much better idea for how to handle banks’ derivatives books:
http://www.nakedcapitalism.com/2010/05/you-say-you-are-a-market-maker-great-act-like-one.html">read more...
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