The opposition is fierce, I read, and by last evening there were thousands of pages of letters filed with the various arms of the U.S. government. The goal of the “Volcker Rule” is to limit the risk taken by banks within the U.S. system. An understandable goal, for sure, and one of the more contentious elements of the Dodd-Frank Legislation.
Everyone had their own reason for hating this particular detail of Dodd-Frank, whether it be Canadian banks, JPMorgan (JPM), Finance Minister Jim Flaherty, Silicon Valley Bank, or the U.S. venture capital industry.
For the VCs and SVB, the concern is that banks will be prevented from investing their equity in venture capital funds. SVB estimates that domestic and international banks make up 8% of the LP commitments of U.S. venture vehicles, and that this is an “unintented consequence” of the admirable American attempt to limit banks from taking risk. Apparently, investing in VC funds is far less risky than prop trading. It is true, of course, that a combination of high leverage, a lack of liquidity and sub prime mortgage investments brought down Lehman Brothers in 2008. And one can’t deny that a bank should have the right to make a strategic decision to invest in a series of VC funds in the hopes of making an appropriate return…plus earn fees from the VC’s portfolio companies and capital call lines. But is VC investing without risk? No one would make that argument. Is it risk that can wipe out more than the capital you’ve committed, the way a levered prop trade might? No.
The goliaths, such as JPMorgan, are trying to ensure that they retain the right to make markets in corporate bonds, for example. Whenever I try to buy a corporate or sovereign bond, I find the bid-ask spreads to be incredibly wide; painfully so. It would put the stock market to shame. There’s liquidity out there, in a manner of speaking, but it’s often the pits.
As Bank of America (NYSE: BAC) wrestles with the ongoing litigation that it inherited as a result of its Merrill Lynch acquisition, you’ve got to wonder how happy shareholders are to own an investment dealer in this day and age. BMO Financial (BMO) had a $400 million “fraud” perpetrated on it in the nat gas space. UBS (UBS) saw US$2.3 billion blown at the hands of an allegedly rogue trader. There was the SocGen (OTC:SCGLF) debacle of course. This list goes on, proving that no lessons were learned from Nick Leeson, the industry poster boy for such things. No amount of risk management and compliance has yet to overcome the human desire for immediate financial gain.
The solution is simple. Butterfly the industry. Banks should be in the lending business, with modern day wealth management being a natural extension of hundreds of years of private banking tradition. Investment dealers should ply their trade in the stock and bond markets. They need not be housed under the same roof for the economy to work effectively. All that has happened since the “four pillars” came down has been an increase in risk, earnings volatility and bank executive compensation. Customer service scores haven’t gone up merely because corporate borrowers were forced to use their lenders for M&A advice. Au contraire, I’d argue.
If shareholders like the risks and rewards that come with owning an investment bank, they can keep their new shares, post butterfly. Just as people did when John Labatt dividended out its stake in Ault Foods. If not, bank shareholders can sell them to someone who would have bought stock in Goldman Sachs (GS), Bear, GMP, or Midland in a prior life. Those people are out there, looking for growth stocks.
And the FDIC will no longer have to worry about depositors and taxpayers unwittingly guaranteeing risks taken by a few guys in red suspenders.
The Bank of Nova Scotia (BNS:TSX) has paid a dividend since July 1, 1833, and it doesn’t need an investment banking division to keep the lights on. Time to face the fact that there is no effective subtle legislative solution to the recent banking crisis.
Disclosure: We own BNS in our household.