By Michael Tarsala
There's a new Marketplace Whiteboard presentation from Paddy Hirsch at American Public Media - a simple, clear illustration of the risks inherent in prop trading operations by the world's largest banks.
Meanwhile, the debate rages as to whether the Volker Rule, the part of the Wall Street reform package expected to curtail prop trading operations, really has the teeth to take a bite out of systemic risk.
Lobbyists, of course, are still trying to water it down before the rules take effect this summer. Their main objection is that regulation in theory could hamper liquidity by stifling the type of market-making banks perform on a regular basis -- a complaint some say may be more theoretical than actual. Others say the threat is real, and it's already affecting capital costs.
But there is one very clear conclusion about the Volcker Rule: It is chasing the world's top traders away from the banks, and straight to the hedge funds.
A cynic will say, "big deal". Prop traders will operate the way they did before, only somewhere else. There is an important distinction: They will now be distanced from bank deposits. A bad trader with poor oversight could still sink a fund. But at least it won't be a bulge-braket bank!
The prop exodus continues. Just this week, the only macroeconomic prop team at UBS left to form their own hedge fund.
Those type announcements have been ongoing for a year now. This link from Investment Law Group (see Where's A Prop Trader To Go) details how some of the top former traders at Goldman, UBS, MerrillLynch and other banks have all become hedgies.
How will any of this affect you, the independent investor?
Well, it probably won't right away. Over time, we can only hope it will help prevent the type of historic bank leverage buildup we saw in 2007 that contributed to the financial crisis.
This is aspirational, but I do hope for two additional changes in the spirit of investing democracy:
1) Future regulations and product advances help make more hedging strategies available to the individual investor. Long-short and hedged strategies that are not levered to the hilt can offer better risk-reward than long-only strategies. It's about choice. And if you ask me, there should be better choices available to the "average" person with a 401k and a brokerage account.
2) Hedge fund disclosure gets another look. This is not impossible. At Covestor, every one of our model managers -- even the ones with long-short and quantitative strategies -- discloses their trades as soon as they make them. Whether you are invested in their strategy or not, you can go to the site and see what they are doing, move for move.
Want to level the playing field between hedge funds and the rest of the investing public? Make the top hedgies disclose their trades in a timely fashion, too.
And while you are at it, let them set a management fee and model their accounts so that everyone has access to the smartest strategies.