Six reasons why the Volcker Rule may be a load of guff

There are those who think the Volcker Rule is a huge deal. Meredith Whitney number's among them. Meredith's research notes are confidential, so no one outside her select group of clients knows precisely what Meredith thinks, but Alphaville says it's something along the lines of whatever happens, regulation is definitely going to increase from now on.

Nevertheless, there are those who think Meredith might be wrong and that Volcker's no big deal. To them, it's merely the marketing ploy of an increasingly desperate politican and the ultimate effects will be negligible.

Here, therefore, is why the Volcker Rule may yet turn out to be (a lot) of hot air and everything could continue precisely as before.

1). Lobbyists are (quietly) going into overdrive

When Obama presented the rule last week, he took aim at financial services lobbyists, claiming that, an "army" of them had descended to block commonsense reforms.

This does not mean that lobbyists have boarded a fast train to oblivion. As the Financial Times reports today, they're preparing for some heavy, but quiet, lobbying to get the rule toned down, starting at Davos (which is fortuitously taking place this week).

2) Europe's not into it

If, as seems entirely possible, the Conservatives are elected in the UK this year, Britain may get a version of Volcker.

European countries, however, are far less keen. Reuters last week cited a senior source who is 'close to financial policymaking in the EU,' as saying the rule is, "not fit for purpose in the EU."

"What is key to remember is that the U.S. is one market, the EU is 27 markets and we are trying to encourage cross-border financial services and more importantly consolidation in both national and trans-national markets. The Obama plan would be anti-competitive in EU terms," the senior source added.

If Europe won't participate, US banks could be left at a big disadvantage, and the rule may be dead in the water.

3) There are great opportunities to exploit definitional vagueness when it comes to 'prop trading'

Volcker only prohibits banks from engaging in prop trading that doesn't relate to clients. As various people have pointed out, this is meaningless.

Analysts at Bernstein put it most aptly:

Technically all fixed income trading activities are a form of proprietary trading - a bank needs fixed income inventory positions to make a market in OTC securities. But if a bank has a securities inventory position, the institution is taking market risk. If the bank actively increases or decreases the inventory to profit from a move in client demand from market making, then the bank is flow trading. If it places a position on a desk that is not responsible for market making, then in the definition of Goldman, it is proprietary trading. This narrow definition of proprietary trading in FICC is like claiming that you are "a little pregnant" - there is no such thing - either you are or you are not. As such, either a bank is a fixed income trading house and it is taking trading risk or the bank is not a material participant in the fixed income market.

Determining what's prop trading and what's not will be almost impossible for regulators. According to Naked Capitalism, one bank expects less than 1% of its business to be effected as a result.

4) It has to get through Congress

Although Obama has invested a lot of political capital in the VR, Obama isn't what he used to be. Following last week's defeat in Massachusetts, he's lost his supermajority in the Senate, and Volcker could be blocked by the Republicans (the real question, however, is whether Republicans will want to block any resulting bill given popular support for bashing bankers).

As Felix Salmon points out, there's also no guarantee that Congressional Democrats will fall into line.

And according to Economics of Contempt: "The two Senate staffers I talk to regularly both said their offices were basically ignoring Obama's proposals, because even if the White House fights for them (which they won't), Chris Dodd has no intention of inserting them into his committee's bill."

5) It doesn't make any sense

As various people have pointed out, the Volcker Rule wouldn't have prevented the financial crisis: Lehman, AIG and Fannie and Freddie would, for example have been able to sidestep it. Hedge funds, private equity and prop trading weren't the cause of the meltdown.

Equally, the rule does nothing to address the question of too big to fail, and simply freezes banks at their current size. "Why would anyone regard twenty years of reckless expansion, a massive global crisis, and the most generous bailout in recorded history as the recipe for creating "right" sized banks?", questions Baseline Scenario.

6) It can be avoided

Even if Volcker does come into being in its intended form, it appears to contain a loophole as large as Blankfein's bald patch: banks' private equity and hedge funds can also be kept going as long as they're open to outside investors.

As Clusterstock pointed out last week, even employees could be classified as clients if they invest in internal funds. Problem solved.