This is a guest post on trading from Tusk Trader (check out the newly launched site: www.TuskFund.com), an experienced Bay Street trader who will be writing here until Tusk’s own blog is set up. Tusk had a front row seat to the twists, turns, and almost collapse of our capital market systems a few years ago and provides a unique perspective you won’t find anywhere else. For most people, financial literacy is the elephant in the room. Let Tusk Trader help change that. If you are on twitter, make sure to follow Tusk at @TuskTrader
There is continuing coverage of the Libor scandal. This is a rare case because I believe there cannot be too much attention paid to this issue. Many analysts in the media are trying to draw parallels between the massive trading loses at JP Morgan and the Libor fixing at Barclays. I see these issues as two very different and distinct problems requiring very different solutions. The JP Morgan issue to me is really a shareholder problem. I think it is impossible to craft a legislation that will prevent large firms from doing very stupid things that erode shareholder value.
The Libor scandal is a different beast. It reflects the massive overhaul needed in how we regulate the capital markets. The overhaul required does not just pertain to the rules the regulators are trying to defend but how they are defended and the basic framework of the regulatory bodies. The complete lack of action (on the well-known rigging of Libor) for many years at the highest levels of regulatory institutions leaves me disgusted. This was not just a problem with one person completely ignoring the responsibility of the office they hold (although I do currently harbor particular distain for the behavior of the UK Governor, Mr. King). Overall, I have a healthy respect for most of the people who work for regulators. One element that needs a rethink is the career path and the selection process for people within regulatory bodies. A revolving door needs to be developed within many departments where particular positions are reserved for traders and bankers. Having experience on a trading floor or on a syndication team from 15 years ago is not enough. Recent experience is necessary to properly assess current market rules and the process for discovering who is breaking the rules. The Volker Rule is a great example of a rule that is created by people who are out of touch with the day to functionality of a trading floor. Paul Volker had been trying to get a similar rule to the Volker rule passed for about 20 years and 20 years ago, it would have made a difference. That is not the case now and the JP Morgan loss proves it. Paul Volker is a very smart guy, but his solution is out of date. This is the crux of the regulatory problem. The capital markets are highly responsive to their environment. We need to shape regulatory bodies in the same way.
There is some movement between private compliance departments and regulators (IIROC, OSC etc.) here in Toronto but I have yet to see a meaningful swinging door between a trader or an investment banker and a regulatory position. The regulators need to re assess the career path they like to see in their employees. The people are not the problem, the system of how they groom their people is. I am not saying every high level position at these oversight bodies needs to be a temporary 2 year stint, but there should be some positions that are viewed that way.
Is the best way to catch a thief, to hire a thief? Maybe. Or maybe it is just about hiring a front line person who knows what is happening day to day on the trading floor. It is not about the regulators being one step ahead of the markets; it is about the regulators becoming INSTEP with the markets. We have Mr. Carney, and not Mr. King, but that is just luck. How can we convince more qualified bankers and traders to take a pause for a few years and enter the regulatory framework? Right now I see many regulators as a soccer goalie. When there is a scandal, someone recommends different gloves. It does nothing to change the magnitude of the problem.
Is there a piece legislation that could have prevented the JP Morgan loss? I say no. It happened in the department it happened in because they were “ not allowed” to do it in another according to the Volker Rule. You can’t legislate against stupid. Only shareholders can alter that reckless behavior. What we can change is the gap between the regulators and the markets. Don’t change the people at the regulatory bodies, but change what is expected of their experience and career path they are directed in. I am not assuming this is a quick or an easy fix but to assume the capital market system needs an overhaul and the regulators do not, is devoid of logic. The Libor rigging shows more flaws in our regulatory structure, process and oversight than it points out in Barclays.