Archive for January, 2010

The Paul Volker Rule aka Obama’s Bank Breakup Plan

22/01/2010

Obama’s bank restructuring plan announced on TV on 21st Jan 2010 has caused a tremor of 1.0 (only) on the scale in the stock markets the world over. I suspected something was ‘going wrong’ when my daily #Nifty end of day study revealed a definite down turn, with no apparent provocation.

But let me not run ahead of myself. If you have only watched TV, then I recommend you first read the actual transcript of Obama’s speech here. And I also recommend you read the summary and intent of the plan here. I’m not going to dwell on the data (fact) but only on my view/analysis of the plan’s impact as I see it.

My comparison of Obama to Mayavathi in my tweets starts and ends with the perception that this plan may have: That it is populist, aimed at bolstering Obama’s sagging popularity ratings. That may well be true in so far as the timing of the announcement, since it comes one year after he took office when Common Wisdom shows every President’s popularity tanks + Paul Volker has been around from much earlier and the reasons for the global meltdown were known well before Obama even took office. Thus there is ground for believing the world’s most popular politician knows the idiom: Timing is everything in politics.

But my comparison of Obama with Mayavathi strictly ends there. His plan – or should it really be called by the name he’s given it: The Volker Rule, is incisive in its logic. If implemented, this plan will indeed make for better stock markets, economies and hit the insider ring a debilitating and possibly fatal blow. Time will tell.

For those who are familiar with how “institutional” trading works, I need say no more. But for those who don’t, apart from pointing you to the Raj Rajaratnam insider trading scam, I’d point you to the Indian laws that require “an arm’s length” between banks and even their broking arms, mutual funds and so on. This is because any collapse of these huge amounts of funds can and will result in a misuse in favour of the institution or bank that owns the companies and the public depositor or investor would suffer. This is often referred to as the ‘Chinese Wall’. And everyone knows that ‘paper thin’ Chinese walls are meant for papering over privacy. Which is exactly what the Volker plan intends to change.

The “if you want a fight, I’m, ready” statement hit headlines thanks to its more controversial nature. TV loves TRPs. That’s all. The real intent is summarized in two paragraphs in the documents I recommended you read (above). But the core TWO intents are reproduced below:

First, we should no longer allow banks to stray too far from their central mission of serving their customers.  In recent years, too many financial firms have put taxpayer money at risk by operating hedge funds and private equity funds and making riskier investments to reap a quick reward.”

And second:

The fact is, these kinds of trading operations can create enormous and costly risks, endangering the entire bank if things go wrong.  We simply cannot accept a system in which hedge funds or private equity firms inside banks can place huge, risky bets that are subsidized by taxpayers and that could pose a conflict of interest.  And we cannot accept a system in which shareholders make money on these operations if the bank wins but taxpayers foot the bill if the bank loses.”

Having understood that the intent is honourable and required, lets briefly see what could be the impact.

Firstly, it is related to stock markets and to trading in particular. Its direct impact would be that the ability of manipulating markets will be diminished because the sheer size of funds would be reduced, not to mention increased risk for insiders. No doubt, fund managers can still act in unison. But that’s neither guaranteed nor possible at all times and in all circumstances. Moreover, they would be susceptible to easier discovery and punished under insider trading rules that already exist if at all there is any wrongdoing.

Secondly, each fund manager will control a smaller size of funds, by the very act of a splitting of entities holding these funds. This in turn would mean a fairer price discovery would take place on the exchanges.

Thirdly, bank managers will find it difficult to enjoy the obscene bonuses that they reaped from leveraging investor funds to their advantage. Banks won’t be allowed to perform non-core services: accept deposits and lend to businesses and individuals.

Fourthly, Banks will be forced to lend more to businesses and individuals since they can no longer chase speculative trading and investments. That can only benefit the economy.

Fifthly, hedge fund and private equity managers will no longer be able to place losses at the feet of investors while reaping profits for the company or chosen few. That means we should see less well disguised cheating taking place.

Lastly, money must and will chase the best growth prospects. Whether it is managed by A or B, performance will drive investments, as it has done from time immemorial. That’s not about to change. If anything, it’ll be more nimble since the size of funds would become smaller (in time).

But the story only starts now!

The fat cats of Wall Street will not give in without a fight. That’s probably why Obama even mentioned it in his speech, indicating his readiness to take them on. This is the troubling issue. The only people who will be adversely affected by the Volker Plan are the top bank (fund) managers. But these are people who have bought themselves plenty of clout, not to mention IOU’s from powerful people. Thus we can expect a stiff fight in the US congress. But the master politician Obama (and his team) have the people on his side, firmly. It’ll become politically suicidal for too many politicians to oppose the plan publicly.

So what can happen during this period of ‘uncertainty’?

The preparatory separation of funds would see some selling pressure in the stock markets.

The booking of losses in investor accounts can accelerate.

For Emerging Markets, the losses would be temporary since money from whichever fund manager would eventually have to chase performance. GDP being the “Good” word.

The news that some countries in Europe are already lining up behind Obama not only shows vox populi is firmly behind the plan, but also that it is the right thing to do. The pressure on others in EU to join will only make things better for better stock markets.

Nobel Laureate Obama has not only launched a war in Afgan-Pak but also on the financial services sector. If he persists with both, to the end, he’ll win both. If the most popular US President can’t do it, then …….

Notice that only fund managers are complaining.

I was waiting for the correction in #Nifty to be over before going long again. But now I’m not expecting any big time further tanking in #Nifty and think that stock selection would be the way to trade in 2010. My first list I’ve tweeted in our Nifty traders group on twitter: @NiftyGroup – come and join us.

If you’d like to discuss this or leave a comment, please do so on twitter at: @jsvasan or @NiftyGroup

3 Cheers to Obama! And Paul Volker!

JS

Posted via email from Nifty Futures Trading

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