The past week made me especially grateful for Cuban coffee. I drank so much that by Friday night I was speaking Spanish. In addition to the usual routine and planning for IIM’s annual meeting next weekend, I spent a considerable amount of time doing two things I’d just as soon avoid: thinking about financial regulation and reading political strategy missives.
It is the nature of markets that sometimes events as distant as the surprise election of a Republican senator in a formerly deep blue state can have huge and previously unforeseen ramifications. I, like many others, did not see Scott Brown’s last Tuesday victory coming a month ago, nor had I really considered its impact on the markets beyond the myopic and obvious “that oughta be good for healthcare companies” kind of thought. But by Thursday, President Obama’s speech on the Volcker Rule made it fairly clear: some huge new variables just stormed through the door for investors.
In case you missed it, the administration intends to prohibit banks from running hedge funds, private equity funds and participating in the very profitable practice of proprietary trading, and, well, that’s a big deal – in both action and intent, as the market’s subsequent sell-off underscored.
Here is the announcement:
To be clear, there is still a high degree of uncertainty about how this proposal will play out. Congress will no doubt take its time to enact these changes, during which time bank lobbyists in DC will multiply like rabbits.
And far as what these variables mean to our portfolio companies, the answer at least in the short-term is “nothing.” I am already hyper-allergic to regulatory risk in our holdings, which is one reason we don’t own shares in any banks or health insurance companies.
But without being too dramatic, I think there is a reasonable probability that we may have just seen the formal beginning of a generational shift in this country’s attitudes about capitalism. Or, at least, that is where all this could be going if the early political tea leaves prove correct.
Here’s the best article I’ve read describing the political calculus that is likely involved behind the scenes. It’s from Simon Johnson at MIT, who has been out front in many ways on his Baseline Scenario blog. Here’s his assessment of the current political calculus going on in the White House:
Think of it this way. If the Democrats lose badly in November – as seems likely, with their current weak and unconvincing narrative about the financial crisis and origins of our mass unemployment – then President Obama’s reelection campaign will be a long struggle to redefine the message, presumably toward finding something he has changed in a major way. In that context, strong attempted action against the power of big banks would appeal to the left, center, and even part of the right. Why wait for defeat in November before making this switch?
Run hard now, against the big banks. If they oppose the administration, this will make their power more blatant – and just strengthen the case for breaking them up. And if the biggest banks stay quiet, so much the better – go for even more sensible reform to constrain reckless risk-taking in the financial sector.
The difference, then, between this week’s Volker Rule announcement and the previous year’s half-hearted attempts to reform the Street is that this time they mean it. Financial reform is now at the center of a fight which will be politically convenient, entirely one-sided and easily satiate the masses. If this recent change in strategy is in fact successful in solving the President’s current political problems, then it may redefine both politics and Wall Street for at least the next seven years.
We can get a glimpse of other potential White House financial reform proposals thanks to the hyperkinetic Tyler Durden(s) over at Zero Hedge. Tyler dug up the below report, published a year ago by the “Group of 30,” a little-known DC think-tank led by Timothy Geithner, Larry Summers and, yes, Paul Volcker. It touches on reforming everything from rating agencies to accounting to Fannie Mae, and it could very well prove to be a blueprint for regulatory change over the next few years.
If you are an investor, you owe it to yourself to at least skim the below in an attempt to gauge how much these changes could impact your own portfolio. Like, later today. Seriously. If nothing else, just watching five minutes less of Terry Bradshaw will make you smarter. If you have questions about anything in here, ask your advisor about them. If he can’t answer them, fire him. Regulatory risk just became the biggest potential headwind in your portfolio over the next fourteen conference championship games, and after last Thursday, the “didn’t see it coming” excuse shouldn’t cut it.
Though I try hard not to be cynical about politics, I concede I am a bit disappointed that these proposed changes seem to have been driven by political justifications, not moral ones. The collapse of Bear Stearns happened almost two years ago, yet it was only an off-the-radar Senate race two days ago that gave the political handicappers the odds they wanted to come out in favor of aggressive reform – or at least of appearing in favor of it.
And as much as I bash Wall Street – and unequivocally agree that changes are clearly needed – I find myself, surprisingly, lukewarm at best about the Volcker Rule. I suppose my usual skepticism of institutional motivations may have just gotten trumped by, well, a bigger institution. Or maybe it’s the law of unintended consequences that concerns me. Regardless, if we as a country decide to selectively begin real, critical financial reform to prevent another global financial meltdown, I’m in. If we end up doing this as punishment, though, or because we want retribution from Wall Street, well, then, I’ll be out fishing under Long Key bridge.
I consider myself a strident advocate for more transparency, disclosure, and above all, enforcement in the markets. While this new proposal has some merit, it is only in the context of fixing what we’ve already got. It’s also easy to see this thing end up getting highjacked during the legislative process and becoming a big distraction from one of the dozen other Really Important Things we as a country need to be working on. Like a playoff system for college football.
All that said, I really don’t want to see another crisis like the one we just went through. Ever. So I will hunker down and get onboard with this reform – if the powers that be in DC and Manhattan remember a few things:
The markets exist to serve us. We get into trouble when we start thinking it’s the other way around. Our elected representatives also exist to serve us. They, too, get into trouble when that order is confused.
So no matter what is in store during this upcoming battle, we should all be hoping that both sides remember who it is they’re working for.