Making a Theoretical Case About Volcker

Show, don’t tell.

That approach is often the best way to explain a complex subject — and persuade people of your case. But it seems to have been underdeployed in the letters submitted to regulators on the Volcker Rule, which attempts to stop proprietary trading at financial firms that enjoy a government backstop. An unusually large number of comment letters had been filed by Monday, the deadline for responding to a draft of the rule that was outlined in October.

Both supporters and critics have largely relied on arguments that — while sophisticated and technical — are merely theoretical. The letters tend to lack the sort of numerically supported real-world examples that could shed more light on the issue.

Take JPMorgan Chase’s 58-page letter, which is mostly critical of the draft rule. It contained several assertions in support of its case that the rule “would have serious, adverse effects on our ability to manage our risks and address the needs of our clients, and on market liquidity and economic growth.”

While it does make plenty of detailed references to specific businesses at JPMorgan, the arguments lack quantifiable references. One segment of the JPMorgan letter does stand out. The bank contextualizes an argument in an actual event. In it, JPMorgan describes the moves it made during the financial crisis to manage an inflow of over $100 billion in deposits — and expresses doubts about whether it could make the same responses under the Volcker Rule.

Letters from Credit Suisse, Morgan Stanley and Bank of America also had few fleshed-out examples from their own operations.

Real-life numbers could inform a key debate over banks’ market-making business, in which they hold inventories of securities to facilitate customer trades.

One of the main arguments against the Volcker rule is that legitimate market-making would be classified as trading and have to stop. Some market-making revenue is attributable to fees and other costs borne by customers, but some is from price movements in the securities the banks are holding – a source that might be classified as trading under the Volcker rule.

It would be helpful for banks to break out these sources in their comment letters, said Kurt Schacht, managing director of the CFA Institute, an organization that promotes ethics and standards in the financial industry.

“It could show the extent to which market-making tips into proprietary trading,” he said.

But in their comment letters, several banks said attempts to break out client-specific revenue would not reflect how market-making works. At the same time, Morgan Stanley said that that market-makers “will have substantial revenues from market movements of their principal positions.”

Knowing how substantial might help explain why the banks have spent so much time and money fighting the Volcker rule.