Just as we suspected, the “Volcker Rule” proposed by the Administration fails to acknowledge the new facts on the ground: that the crisis took place in the capital markets, and that some of the major participants were funded by deposits was incidental. Half of the balance sheet of major dealers comes from repos, and a seize up in the repo markets was a major (and generally unacknowledged) crisis mechanism.
Some institutions will be able to avoid facing the Volcker rule by shedding their insured deposits, according to U.S. Deputy Treasury Secretary Neal Wolin on Monday.
Goldman Sachs Group, which funds fewer than 5 percent of its assets with deposits, could easily change its funding profile to get out from under the rule.
So the Treasury would like to get tough with banks that hold a lot of deposits, and blithely ignore the fact that it rescued (via forced mergers) Bear and Merrill, neither which held deposits, that the failure of Lehman, again, not a depositary, nearly precipitated a systemic collapse, and that the powers that be felt compelled to rescue AIG, again not a depositary. Oh, and that it allowed Goldman and Morgan Stanley to become banks and receive TARP funds because their failure was feared to create a systemic failure.
Notice that the Reuters article focuses on the idea that the plan could conceivably work, ignoring that it will preserve the worst aspect of the status quo: that guarantees have been extended to capital markets firms, and a considerable portion of them are not going to subject to more strict regulation as a result.
So if this proposal moves forward (but all indications are that it won’t), expect Bank of America to spin out Merrill post haste and for JP Morgan to engage in loud complaints about how unfairly it is being treated (Citi would like to as well but presumably knows better). And that over time will lead to the rule being gutted. The reason Glass Steagall became irrelevant (and it was well before it was formally rescinded in 1998; the only practical consequence of that act was to remove an impediment to the Citigroup-Travelers merger) was that commercial banks had pointed to how investment banks were eating their lunch and earning more money and demanded a more level playing field. They got a series of variances starting in the 1980s, with the result by the mid-1990s that commercial banks were represented in the top ten in pretty much all major investment banking products. So while the Volcker Rule could in theory lead to a return to Glass Steagall, the big problem, the need for tougher restrictions on capital markets players (NOT depositaries) remains unaddressed.