Clearly this is Their First Rodeo

Mark Thoma

Jan 22, 2010 12:48PM

Economics of Contempt has A Few Assorted Thoughts on Financial Reform. I wish I could disagree with his contention that the reform proposals from the administration represent little more than „a fairly transparent political stunt.“ Maybe I’ll be pleasantly surprised, and I hope I am, but it’s hard to be optimistic (and things like this don’t help):   

• The single best thing we could do for financial reform: Triple the budgets of all financial regulatory agencies. Immediately. Regulators are woefully understaffed; this is fact.

• Obama has proposed banning banks‘ prop trading desks and internal hedge funds. I’m fine with that, as long as it’s done properly. From a P&L perspective, this is obviously bad for the Street. From a public policy perspective though, there’s really no compelling reason why the banks need to have prop trading desks or internal hedge funds.  But you can’t simply prohibit banks from buying and selling securities for their own account, because that’s precisely what market-makers do. Market-makers have to stand ready and willing to buy or sell securities for their own account, at firm bid and offer prices. If an investor is looking to sell a security, the market-maker will buy the security using its own capital, and hold it in inventory until an investor who’s looking to buy the security surfaces. This is different from having a prop trading desk, which has no market-making obligations, and essentially acts as a hedge fund (except it has the not-insubstantial advantage of being inside the prime broker).

  Some people will claim that it’s impossible to distinguish between market-making trades and proprietary trades, but that argument is completely baseless. The banks themselves already distinguish between their market-making trades and their proprietary trades, as there’s a whole different set of rules for proprietary versus market-making trades. So don’t be fooled by that argument.

  In any event, I don’t even know why I took the time to write about this, because there’s zero chance the proposals Obama announced today will ever be law. This was a fairly transparent political stunt — the White House needed to do something to take the media’s focus off of health care 24/7, so they flew in Volcker and announced some proposals that sound good to the media. The two Senate staffers I talk to regularly both said their offices were basically ignoring Obama’s proposals, because even if the White House fights for them (which they won’t), Chris Dodd has no intention of inserting them into his committee’s bill. I like how some people think Obama’s proposals represent a fundamental turning point on financial reform, because….well, clearly this is their first rodeo. (Hence the uber-quixotic language they use to describe financial reform.)

• This, from John Taylor, is just sad:  
  

  „[N]ot one counterparty, derivative counterparty to Lehman, filed for bankruptcy after the Lehman case. The major creditors who did not fail. So it’s hard to find a direct knock on effects from that in the data.“

What?! First of all, Lehman’s biggest derivatives counterparties — the other dealers — were virtually all bailed out by their governments. Second of all, there were lots of hedge funds that failed because of their open derivatives positions with Lehman, and especially with Lehman Brothers International (Europe). The fact that John Taylor didn’t know about these hedge fund liquidations at the time doesn’t mean they never occurred. They occurred. Oh believe me, they occurred.