Paul Volcker. Photo courtesy The Edmond J. Safra Center for Ethics at Harvard University.
It seems fair to assume that the stewards of American capitalism would be aware of the maxim that nothing in life comes free, not to mention the law of unintended consequences. But sometimes we can only shake our heads and wonder.
For one example, consider the report in The Wall Street Journal over the weekend that investors in all sorts of securities are finding it harder to buy and sell these assets whenever they want to do so. The ability to trade readily is called liquidity, and whenever it is in short supply, buyers tend to pay more and sellers tend to get less. Middlemen are the typical winners.
Liquidity raised fewer concerns in the unusually long stretch of low volatility that characterized the last few years of market activity. But as market turbulence makes a comeback, both buyers and sellers have noticed that trading is sometimes more difficult than expected. Jeffrey Cleveland, chief economist at money manager Payden & Rygel, told the Journal, “It’s like going into a grocery store and there’s nothing on the shelves.”
Although the weekend Journal article did not make much of the connection, there were plenty of people who foresaw nearly a decade ago that the Dodd-Frank regulatory framework, and particularly the massive “Volcker rule” it imposed to ban most banks from most forms of securities trading, would reduce liquidity. Those concerns were brushed aside at the time, and have been brushed aside many more times since the rule was enacted. Dodd-Frank remains a politically charged topic, with many of the Democrats who enacted it almost as protective of it as they are of the Affordable Care Act and Republicans surprisingly divided over how far to go in loosening its strictures.
The Treasury Department concluded in June that the Volcker rule could stand with “substantial amendment,” and a revision process began last summer. This process was part of a broader evaluation of financial regulation, in which the Treasury Department turned a critical eye on a variety of Dodd-Frank rules. Some of the Volcker rule’s opponents continue to push for full repeal, but that seems unlikely for now. When any proposed amendments will arrive, and what form they will take, remains unclear.
Of course the Volcker rule, and Dodd-Frank more broadly, did not spring from thin air. The near-meltdown of the financial system sparked a search for “never again” solutions that, due to political considerations, were wide of the mark in many ways. Banks took a disproportionate share of the blame for a crisis that the government was at least an equal partner in creating, because government officials – not bankers – make the laws and must face the voters. For the same reason, many of the rules that followed the financial crisis did not address its root cause, which was the willingness of government-enabled banks and investors to lend far too much money to far too many people to buy homes and apartments that were far too expensive to afford. Those buyers are also voters.
Virtually none of the individuals who faced foreclosure or bankruptcy in the financial crisis are securities traders or portfolio managers, however, so there was less reason for Congress to shy away from barring banks from taking allegedly excessive risk through trading and making markets in securities, even though such activities had nothing to do with the crisis. We might choose to believe that at least this step prevents a future threat to the financial system, but if it does, it does so at a significant price that we are now paying in securities markets every day. Is the benefit, if any, of the Volcker rule worth the cost? I doubt it, but it is a question of both math and political philosophy on which others will disagree. Even those who agree the rule is flawed in its current form disagree on how, or how much, to revise it.
Similar effects play out in many other areas of public policy and the world of finance. Our securities laws are designed to protect ordinary citizens – who are presumed to be largely clueless – from making inappropriate investments. As a result, most small investors have little or no access to funds that invest in nonpublic companies, which are often promising startups. This may not always be a bad thing: Many startups fail, and even diversified portfolios of such companies can perform very poorly.
Yet at the same time, our finance and tax laws actually encourage people to concentrate their retirement investments in the stock of the publicly traded, and usually large, company that employs them. This concentrates risk in a way that makes little sense. In another recent story, the Journal profiled workers and retirees from General Electric who have seen their nest egg depleted because GE’s declining fortunes since the financial crisis have bucked the overall trend of a phenomenally recovering stock market.
Most government rules, like those Dodd-Frank created, spring from benign intentions. Very few regulations in the government’s vast portfolio serve no purpose or produce no benefit at all, which is one reason it is so difficult to get rid of any that are enacted. Everything has a constituency. But everything also has a cost, regardless of whether, when or how we choose to recognize it.