Thursday, January 21, 2010

Prop trading?

I post Cowen's posts here because they have a very intelligent response.

Firstly, I'll say that I have no problem restricting prop trading by commercial banks. There aren't significant synergies, and as long as the banks are able to spin off or sell their prop trading divisions, it's not a negative to the banks or to the economy. It may actually make bank incentives more inline with treating customers well. (The net effect is that prop trading can't prop up commercial lending or vice versa when one is in trouble, so you probably see more frequent credit issues, but they can never bring each other down no matter how big they are, so they're less severe. Given the structural dislocation in this severe shock, that's probably neutral to slightly positive).  [EDIT: I have written more on this since then, and I have started leaning against prop trading restrictions... it raises the cost of capital substantially by making counterparties harder to find]

The problem I have is the "too big to fail" component. Firstly, I've chronicled my objection to "too big to fail" many times before:

There are problems. A cap on the size of bank assets means that banks can treat customers badly, because they don't need to attract them (Cowen's point). Worse, it means high-profile banks (especially those with extensive ATM networks) can extort from their customers - lower interest rates, ridiculous fees, low security, etc - because they know that if the customers go anywhere, others will just pop up, and the ATM network and brand mean they'll never have trouble attracting them. Another question is of fairness - if you prioritize people who already have accounts, then low-income and young people who don't have accounts will find it very hard to find a decent bank, discouraging banking (which is a very bad thing, as I've noted before, because it makes money less secure, and thus more likely to be spent quickly - often on wasteful things. Estimates have as much of 20% of income in poor countries spent on prostitutes, drugs and alcohol).

Does this mean we will have many more ATMs as banks try to compete for who can charge fees? And will banks split into "inaccessible banks with low fees where people keep the bulk of their savings" and "accessible banks with high fees where people keep only what they need imminently"? Will banks in the former category continually try to move to the more-profitable latter, causing massive account churn (and high fee generation) as customers switch accounts?

The other problem is what it doesn't do - the legislation doesn't do any of the somewhat necessary things that I've chronicled many times recently:

Any of these could be addressed with further reform bills... incremental is not a bad thing! It's also possible they haven't been announced as part of the bill here.

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