We know it when we see it
By David A. Smith
4 min read
I know it when I see it.
– U. S. Supreme Court Justice Potter Stewart,
defining pornography in Jacobellis v. Ohio, 1964
Stuffed into the Dodd-Frank legislation, the tangible manifestation of the witch hunt after the subprime collapse, is a provision, the long-awaited and long-delayed Volcker Rule that put the entire LIHTC business at risk. Hauled out of retirement to chair President Obama’s task force, former Federal Reserve Chair Paul Volcker believed America’s housing bubble was caused by financial sin: nefarious investment banks subverted wholesome commercial banks, taking consumers’ deposits and used them to concoct toxic assets flipped for fast bucks. Volcker (both the man and his rule) sought to stamp that out, prohibiting banks from “engaging in short-term proprietary trading…for their own account [or] owning, sponsoring, or having certain relationships with hedge funds or private equity funds….”
A Knock at LIHTC?
When enacted in 2010, the Volcker Rule sounded simple – yet it gobsmacked the low-income housing tax credit crowd.
Did the rule prohibit banks from buying LIHTC equity? Would all the banks suddenly to be out of the LIHTC business?
The statute’s words basically say it does. Banks buy private LIHTC equity for their own account. Some sponsor proprietary funds; others guarantee funds. Some trade their positions. Investor, sponsor, guarantor; all these are market-making activities.
Sounds prohibited, doesn’t it?
Like Potter Stewart, Mr. Volcker claimed that he could distinguish virtue from vice, but was incapable of defining vice by rule; he just he knew it when he saw it. That isn’t law, it’s caprice, and his gnomic 37-word commandment drew more than 18,000 written comments, some of which were:
- Cautionary. “It is devilishly difficult to draw bright lines between proprietary trading and trading, hedging, and market-making on behalf of clients.” – Alan Blinder, Princeton economist
- Metaphysical. “If you want to be trading, you have to have a lawyer and a psychiatrist sitting next to you determining what was your intent every time you did something.” – Jamie Dimon, CEO, JPMorgan Chase
- Sarcastic. “Paul Volcker, by his own admission, has said he doesn’t understand capital markets. Honestly, he has proven that to me.” – Jamie Dimon again.
The Elusive Definition
In truth, no Volcker Rule definition can be written, because banking versus investment banking is like art versus pornography: the activities are nearly identical and differences (if any) lie solely in the minds of producers and consumers. At its core, every bank is an investment bank; some just do it visibly and for profit. Deposits (liabilities) get repackaged as loans (assets) with rate mismatches, maturity mismatches, risks and hedging, and so on. All these are investment banking activities, but done for so many decades that, like the bathing suits of a century ago, what once was risqué is now the soul of modesty and decorum.
For that matter, what is an “essential” banking activity, anyway? The Community Reinvestment Act basically compels banks to buy and hold LIHTC positions. Is proprietary trading no longer pornographic simply because the federal government has told you to do it? For three and a half years, the regulators bashed about on the topic, hoping by a barrage of words to pound the concept into submission. Along the way, they inflated trial balloons such as to exempt “municipal securities” (what are those?) or investments that “promote the public welfare” (which ones don’t?), in effect substituting new undefinable words for old ones.
In December the regulators gave up. Instead of defining exempted activities by type, they simply listed particular affordable housing activities they adjudicated as exempt, not out of principle but expediency. “I shall not today attempt further to define the kinds of material I understand to be embraced within that shorthand description; and perhaps I could never succeed in intelligibly doing so. But I know it when I see it, and the business involved in this case is not that.”
That last quote isn’t actually from Paul Volcker; it’s from befuddled Potter Stewart. And just as America’s obscenity laws eventually dissipated into nothingness, so too will the Volcker Rule’s trading prohibitions.
For now at least, we know it when we see it.
David A. Smith is Chairman of Recap Real Estate Advisors, a Boston-based real estate services firm that optimizes the value of clients’ financial assets in multifamily residential properties, particularly affordable housing. He also writes Recap’s free monthly essay State of the Market, available by emailing dsmith@recapadvisors.com.
