Where’s the risk?

Critical macroeconomic questions from a 20 year old.

The following questions have been weighing on my mind as a young American interested and fairly engaged in the capital markets. I’m concerned about the direction of America’s banking giants as risk and speculation are virtually eliminated (by law) from the equation. How could less risk worry me more? While the horrors of subprime lending and other ultra-risky investments played a huge part in the Great Recession, our nation must not forget the necessity of risk in the growing of capital with the purpose of providing the wholly necessary services of a global investment bank. If a bank does not profit, how can it possibly continue to lend (ceteris paribus)?

While unethical loans and firms “too big too fail” are unacceptable, what happens when liquidating banks causes risk in general to be completely diminished? What happens when America’s financial giants cannot turn a profit because they are required to hoard cash while consequently observing their assets steadily diminish in value? Will investment banking be completely transformed for the better or will our system be screwed on a macro scale? By that I mean, will any firms be able to make the markets anymore? Who will fill this role? Certainly some legislative changes were needed after the Great Recession. Of course subprime lending remains unsustainable, but the mighty US Government cannot utterly stifle a bank’s ability to turn a profit. So, is the Volcker Rule the answer?

The rule generally states that permitted market making is taking positions with a reasonable and demonstrable interest of clients while proprietary trading of a bank’s own account is explicitly outlawed. But who will even make these trades as banks have whittled down their trading staff in favor of compliance officials? (Or in the words of Mr. Peter Wallison: Substituting employees who produce no revenue for those who do is the legacy of Dodd-Frank) Wouldn’t you say proprietary trading remains in the interests of the bank’s ownership, its shareholders. What about them? And folks, it doesn’t take a rocket scientist to say the markets and therefore clients are unpredictable. Where will the SEC and other governing bodies draw the line of “permitted market making”? What truly constitutes a bank’s account vs. that of its clients (whose funds in reality are stored in their chosen banks account). Making money requires risk at all levels.

The inevitable business cycle laughs in the face of profit-stifling regulation during a boom. They say what goes up must come down but is this the resulting downturn necessarily an equal effect? If our leading financial institutions are prohibited from making money, how will we as a nation create any new, real, substantial wealth? How will our economy grow? Who will lend on a macro scale? Furthermore, what investor in their right mind will even purchase bank equity (this may be my greatest concern)? Who will provide liquidity in the markets? Who will provide prime brokerage to hedge funds? Will shorting stocks even be possible (chew on that one a bit)? Maybe the US will be lenient in their overall enforcement of the Dodd Frank legislation but their penalties concerning the housing bust have been substantial. Increased liquidation in the short term, stagnation in the long. Does anyone have answers to these questions?

…and please don’t tell me it’s more regulation. Maybe I’m wrong but where oh where is the risk?

***My new question: What if Apple opened its own bank?