Peter Wallison makes the point that, by restricting legitimate market-making by banks, the Volcker rule figures to make banking crises more likely not less so.
[A]llowing banks to trade for their own account is now good banking policy. Not only is this a profitable business for which banks are uniquely qualified, but it enables them to diversify their activities away from corporate lending, where they’ve been outdone by more efficient securities markets. For many years, companies large enough to access the securities market have been able to meet their financing needs less expensively by issuing bonds, notes and commercial paper instead of borrowing from banks.
Banks, in turn, have been forced to concentrate their lending in the volatile business of real-estate finance, particularly local real-estate development. In 1965, less than 25% of all bank lending was based on real estate, but by 2008 this number was 55% and climbing. If this continues, real-estate downturns will lead to more banking crises.
Bank proprietary trading, however, is a win-win-it benefits the markets while providing banks with a revenue stream other than lending. . . . [Emph. added]
Wallison points out, too, that it wasn’t even proprietary trading by banks that caused the credit crunch in the first place. Rather, it was a common shock: everybody owned the same asset-subprime mortgages-when it went bad. The smart policy response should be to encourage more asset diversification not less. The Volcker rule does exactly the opposite. Brilliant. . . .