Five Prime Advisors
Five Prime Advisors


Some thoughts on valuation, regulation, development, & investment

Repeal of the Volker Rule

The Financial Choice Act of 2017 seeks to repeal the so-called Volcker Rule, which prohibits banks from engaging in proprietary trading, and restructures the Consumer Financial Protection Bureau, created by the Consumer Financial Protection Act of 2010.  Repeal of the later would subject the CFPB to congressional oversight, including the appropriation process and judicial review.  Its director would be replaced with a commission comprised of members from both parties. While this ostensibly appears to be a bipartisan step forward, given the polarized rancor of the two parties surrounding issues of consumer protection, repeal effectively neuters the commission’s ability to pursue enforcement of CFPA-created consumer protection laws.  Further, in the unlikely event that the commission were to find common cause, the proposed act would greatly limit the authority of its members to take action against firms engaging in abusive practices.

The Volcker Rule, which is part of the sweeping and transformative Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010, was intended to ensure that institutions whose failure could bring down the financial system are not engaging in the sort of risky trading practices that contributed to the financial crisis.  The failures of Bear Stearns and Lehman Brother, and nearly Goldman Sachs, were the result of outsized bets these firms took for their own gain. Legitimate market making activity does require a dealer to take trading positions based on a directional view of the market.  However, rules regarding the size of these positions would be relatively straightforward to formulate.  Republicans in Congress argue that the Volcker Rule has resulted in a loss of liquidity in more thinly traded securities, particularly corporate bonds.  This may be. But it wasn’t elephantine bets on corporate paper that brought down Bear and Lehman.

Jeb Hensarling (R-Texas), author of the current legislation seeking to “repeal and replace” Dodd-Frank, makes a curious argument that a bank’s equity holders have a strong incentive to keep risk-taking on the part of management in check.  While one would believe that the power of aligned incentives offsets the underlying agency issues of management risk-taking to the detriment of shareholders, government bailouts are still fresh in the memories of bank CEOs and their risk managers.  My guess is that without the regulatory teeth of Dodd-Frank, the issue of moral hazard and excessive risk-taking will remerge as a serious threat to our financial system.

Like much of the current Republican legislative agenda, there is something wide-eyed and facts-be-damned about Hensarling’s untested belief in the power of markets.  In contrast, Alan Greenspan, that disciple of Ayn Rand and great champion of unbridled capitalism, in testimony before the House Committee on Oversight and Government Reform on October 23, 2008, confessed: “Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief.”

Chairman Greenspan, to his credit, had the intellectual honesty to admit that his economic and political ideology had failed him, and that the policies he promulgated as Fed chief had contributed to the market bubble that preceded its inevitable collapse.  While we may earnestly believe something to be true, it doesn’t necessarily make it so.

Peter Meyers