The major one: the Volcker Rule, which is supposed to let insured banks do securities transactions on behalf of their customers but not speculate for their own accounts. That sounds great. But it won’t work. As I predicted, differentiating between market making and speculating is proving impossible to define in a simple, enforceable way. The first version of the proposed rule ran almost 300 pages. Good luck.
Instead of the overhyped Volcker Rule, we need the severely underhyped Hoenig Rule. I’ve named it for Tom Hoenig, former head of the Kansas City Fed and current acting vice chairman of the FDIC. In a marvelous paper presented in May of last year — to my regret, I didn’t read it until this May — Hoenig (pronounced ha-nig) proposes breaking up banks by function, not size. It’s so simple, it’s brilliant. He would eliminate all trading and hedging by banks. If a bank wants to hedge its loan portfolio, it would have to buy a hedge, not make one. “You have to take those high-risk activities out of insured banks, not try to regulate them more,” he told me.
He would allow banks to engage in investment-banking activities such as underwriting bonds and stocks — so we’re not talking about a return to the Depression-era Glass-Steagall rules that Congress repealed in 1999. It’s a smart separation of high-risk from low-risk activities.
He would also alter rules governing money-market funds and change the way “repurchase” transactions are treated in bankruptcies. Money funds would have to mark their assets to market rather than guarantee holders $1 a share. That requirement, combined with the end of the implied federal support of money fund accounts (which the government guaranteed at the crisis’ peak), would enforce serious discipline on fund managers.
The idea is to improve financial transparency and severely limit the “shadow banking system” that allowed the likes of Lehman, Bear Stearns and Citi’s “structured investment vehicle” subsidiaries to pile up money-fund and repo obligations that didn’t show up on their parents’ financial statements.
Hoenig is simple. And workable. And would infuriate Wall Street and its fellow travelers. It’s too bad that Tom Hoenig’s imprimatur is nowhere near as valuable in Washington as Volcker’s is. Hoenig would probably fix “too big to fail.” With Volcker, there’s no hope.
4Taxpayers are off the hook for future failures.
Dodd-Frank reform legislation passed in 2010 is being touted in Washington as a way to deal with future meltdowns of big financial institutions without risking taxpayer dollars or giving creditors a free pass.
It would work like this: The FDIC, using its new powers, would seize so-called systemically important financial institutions — SIFIs — and wipe out their shareholders. It would then convert the SIFIs’ parent company debt to stock in a new SIFI at a severe discount. The new SIFI could then raise short-term cash to fund its operations by borrowing from the Treasury or via Treasury-backed loans. The Treasury would have first claim on everything the new SIFI owns. The Fed would be out of the game.