FT: Dodd-Frank’s long-distance paper chase

We liked this article by the well-regarded FT financial reporter Gillian Tett about the complexities of Dodd-Frank, including the Volcker Rule. Tett points out that the D-F is groaning not only under the weight of the legislation itself, but the comments on the proposed rules. There have been some 25,000 sent to the CFTC alone.

Part of the fun in reading these articles is looking through the posted comments. One from Larry Tabb was particularly interesting and right on target.

The comment from Tabb was: Gillian, Great commentary and looking at Volcker as a stand alone, I think you are right on – it is very unworkable. However, in the medium and longer term – I think most of these rules will be moot. The one with real teeth is actually the most simple. Basle III. If they can stop folks from getting around it – raising capital from 2% to 7% and 9.5+ for larger organizations will make many of these businesses unprofitable. Once that occurs they will be shut down and disgorged. Especially in this really low interest rate environment. The cost of capital (decrease in leverage) will strangle many of these businesses. This is why the one thing that Jamie Dimon is railing about is Basle. It really is the one thing that can really through a wrench in the “modern” bank business model.

Finadium has published two research pieces on Dodd-Frank and Basel III. Our most recent was published on October  “Capital Charges for Margin, Securities Lending and Repo: A Guide for Banks, Their Clients and CounterpartiesHere is a synopsis of the October 2011 Finadium research report and from February “What Basel III Means for Securities Lending and Collateral ManagementHere is a synopsis of the February, 2011 Finadium research report

The full article is below

by Gillian Tett

October 28, 2011

A couple of days ago, a senior banker in New York showed me a memo that he had just received from his lawyers about the so-called Volcker rule for proprietary trading. This stretched to 82 pages on an iPad, replete with dense charts.

And that was merely his summary document; the “full” explanation ran to several hundred more pages. “It’s mad!” he sighed, explaining that this was only one of several memos he had recently received on Dodd-Frank and Basel rules.

It is hard to disagree with that verdict. Almost two years ago, I wrote a column lamenting that the draft Dodd-Frank bill was some 1,300 pages long. After all, I observed then, almost nobody I knew had actually read those 1,300 pages in full; most people were simply too busy to wade through that paper, even as they prepared – or debated – that bill.

But now I realise that those 1,300 pages were the least of the problems. When the bill was finally passed 15 months ago, it had swelled to 2,600 pages, and since then, lawmakers have decided that they will need to make some 243 new rules to turn that bill into law, and conduct 65 studies. That has necessitated the formation of 100-odd committees, each of which is now spewing out consultation documents, which typically run to several hundred pages.

Those consultation documents, in turn, generate endless private sector legal memos. And the agencies are receiving more “feedback”, too. Officials from the Commodity Futures Trading Commission, for example, say that they have now received no fewer than 25,000 – yes, thousand – comments on the proposed rule reforms; some 15,000 relate to their reforms for commodity trading limits. And the CFTC is only one of the agencies involved in this feedback process. By law, regulatory officials then have to read each and every comment before anything can be done; and those submissions can sometimes stretch – you guessed it – to several hundred pages each. That 1,300 page number, in other words, now multiplies a thousand-fold, if not ten-thousand-fold, across the system as a whole; it makes a collateralised debt obligation look almost simple.

Now, many people might argue that such complexity is inevitable. After all, the events of 2008 made an overwhelming case for financial reform, and many of the aims of Dodd-Frank, such as the move to embrace clearing houses, seem utterly laudable. Moreover, it is clearly a good thing to have democratic debate about these rules. And the hard reality is that in America’s rules-based regulatory system, it is impossible to effect legislative change without discussing the details of rules. Paperwork, in other words, is not unique to Dodd-Frank. But I suspect Dodd-Frank has taken this paper chase to a level that has not even been seen in America before, particularly when it is overlaid with the Basel rules. And, as such, it poses at least three interrelated dangers. First, the sheer complexity and opacity of the reform process makes it hard for anyone to forecast with confidence exactly what their net impact will be.

Second, this bewildering process forms rich arbitrage opportunities for canny players. This week, for example, I attended a conference organised by the CME, where the gossip was about how some companies are now moving across borders to dodge rules.

But the third problem is a yawning democratic deficit. One reason why the financial system spun out of control before 2007 was that few non-financiers had any idea how finance worked; 21st century banking had become so complex and opaque, that there was little external oversight, and thus little common sense – and endless opportunity for arbitrage. The bitter irony of the current reform process is that these flaws are reappearing, in a new guise; instead of a world marred by the “CDO cubed”, there is now “complexity cubed”: complex financial products are colliding with complex reform processes run by leaders with complex (or unstated) reform goals. So it is no wonder that public frustration and cynicism about finance is high.

There is, of course, no easy solution to this. Personally I believe that, in an ideal world, it would have made far more sense three years ago to start the reform process by creating a simple global resolution system that could ensure that banks could safely fail – and then introduce measures to reduce the chance of such failures; a greater reliance on simple market discipline, in other words, would have been better than endless bureaucratic rules. But in the real world, it is probably too late to hope for this. Instead, the most practical, real-world question that I am now grappling with as a journalist – and a concerned citizen – is how can anybody normal make sense of this complexity cubed and then explain whether it has made finance better, or not?

Copyright The Financial Times Limited 2011.

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