Foreign governments are joining our banks in lobbying U.S. regulators to exclude sovereign debt from the so-called “Volcker rule” provision of Dodd-Frank,, which restricts banks from trading in securities for their own account. See http://www.bloomberg.com/news/2012-02-01/u-s-regulators-weigh-volcker-exemption-for-sovereign-debt.html The governments contend that prohibiting American banks from trading in their nations’ bonds would reduce the liquidity of the markets and make borrowing more expensive.
Of course, the foreign leaders will have consulted their usual expert advisers on this question, i.e. their banker friends. Why are the banks so eager to persuade everyone that it is good to allow them to trade in sovereign bonds? Could it be because the banks are making a mint on playing games with such bonds? The game is incredibly simple. Express concern in the press, both directly and by advising government front-men, about the financial stability of a country. When this noise causes the price of that country’s bonds to tumble as ordinary investors sell in panic, quietly buy up hundreds of billions of dollars worth of the bonds. Now, go to the international authorities, again both directly and through government fronts, and shout that if the bonds are not absolutely guaranteed then the heavens will fall. When the guarantees come through, sell the bonds that you bought at 20 cents on the dollar for full face value. It is a wonderful game for the banks to play.
American banks find it particularly gratifying. Thanks to our government’s inability to think of anything to do for the economy besides suppressing interest rates, banks can get cash almost for free from us depositors and from the Federal Reserve. The money that you used to get 5% interest on in 2007, you now have to make available to the banks at interest rates that are a fraction of inflation, so your hard-earned savings lose value. The banks turn around and use your money to play the sovereign debt games. This results in an historic transfer of cash from the pockets of foreign taxpayers and U.S. depositors into the pockets of bankers and hedge fund managers. (Some of that profit disappears because it is being used to cover the bad mortgages that started the 2008 mess, resulting from the mortgage games that fed banker and hedge fund manager bonuses in the prior decade).
Let’s try forbidding the banks from playing these games. Deprived of the current huge incentive to bounce the financial fates of nations, the banks may go on to find other games to play, allowing the world to stabilize and reducing foreign government borrowing costs substantially. When the fox tells you that a better fence around the chicken coop will raise costs, don’t take his word for it.