Because fixed income uses about 60% of the capital committed to Wall Street capital markets activities, Hintz concludes that the decline in revenues and margins will challenge firms to even earn their cost of capital. "The changes then necessary will be expense reductions and balance sheet shrinkage," he says. "And with 50% of net trading revenues being paid out in compensation, we know which expense line will be cut!" Even so, he argues, that won't be enough. What will? A reduction in "inventory" of 20% to 25%, the result of which will be a less liquid U.S. corporate bond market, wider bid-offer spreads for corporate borrowers, and a migration of issuance to offshore markets not crimped by overzealous regulators.
In other words, it's bad news for all of us. Actually…not quite all of us. Hintz points out that the U.S. government "conveniently exempted" Treasury bonds from the ban of proprietary trading in the new proposed rules. And why not? When you're the one making the rules, you don't normally screw yourself in the process.
But don't believe all the doomsaying. Most companies in need of financing can just tap another market. Couldn't the bank loan market pick up the slack? Or lending by hedge funds? Or even equity issuance? "Sure, the analogy of a balloon being squeezed comes to mind," says Hintz. "But not every player in the capital markets is equally good in every market. So the overall cost of financing could be driven up. And that could hurt economic growth."
Like many things in the capital markets, the argument put forth by Hintz and Dimon makes sense, at least on paper. The more liquid a market, after all, the more smoothly it should function. But what about in practice?
"The Devil is obviously in the details," says Andrew Milligan, Head of Global Strategy for Standard Life Investments. "On the one hand, the majority of companies issuing corporate debt could do it in any market they want to. Wal-Mart can raise money in sterling or yen, and then swap it back into dollars. On the other hand, if the rules do have what appears to be the desired effect of discouraging investment banks from being market makers, then we lose a shock absorber. Regulators are looking to reduce 'big' volatility—like that of 2008—at the expense of what might be increased volatility in the short-term. We're trading long-term volatility for higher short-term volatility."
There are others who think Hintz is merely sounding an alarm—that the Volcker Rule will prevent so-called "flow trading"—that has no business being sounded at all. "When is [the] last time the financial industry didn't see a regulation that they [said] was going to cause a recession?" economist Simon Johnson asked The Wall Street Journal.
If you accept Hintz's first premise, then his numbers might make sense. If you don't, then his catastrophic conclusions are irrelevant. Could constraining the behavior of dealers in the short-term have a negative impact on financial markets and therefore financing costs? Sure, it could. But reform isn't free, and it's not the end of the world. Even Brad Hintz knows that.
