Markets

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

Gary Cohn should know better than to sow fear of dysfunctional U.S. markets.

Cohn, who recently stepped down as chief operating officer at Goldman Sachs to go to Washington, lived through the 2008 financial crisis, which was ignited when credit markets ground to a halt. He watched U.S. debt markets bounce back on the heels of government bailouts and Federal Reserve stimulus. And he just led his former firm during a banner period for debt trading.

Alive and Kicking
Trading in U.S. credit markets has surged despite rules limiting market-making at banks
Source: Finra's Trace

Yet Cohn seems to think that U.S. markets are fundamentally flawed. Cohn, who's now President Donald Trump's top economic adviser, explained in a Bloomberg Television interview on Friday why it is important to overhaul the banking regulations prescribed by the Dodd-Frank Act of 2010. As part of that, the government will also scrutinize the so-called Volcker Rule, which limits how much banks can trade with their own money.

"All the banks in this country have been hugely burdened by enormous regulatory cost," Cohn said in the interview. "We want well-regulated banks, but we want banks that function. We want markets that function. We want lending to function."

Last I checked, U.S. markets are, in fact, functioning in an orderly fashion. They could certainly work better, particularly among less-traded assets. But the solution doesn't lie in returning to an era of internal hedge funds at banks and highly leveraged Wall Street trading desks.

The fixed-income market, which used to depend on bank traders using their own money to make markets, have been transformed significantly in the past eight years. As banks reduced the money they committed to buying and selling bonds, investors turned increasingly to electronic trading systems and smaller brokerages. Some asset managers became market makers in their own rights.  

Investors have been adapting to a new environment by holding more cash, changing their strategies and making sure they could handle substantial near-term redemptions. Do some traders complain that they can't always get the price they want when they want it? Yes. Does that mean U.S. markets are profoundly damaged, to the point of wreaking havoc on the broader economy? No.

There's certainly room for improvement, particularly in the U.S. government debt market. The Fed, which has been closely studying bond-market liquidity, places some blame on the Volcker Rule for reducing the ability of investors to transact. The lack of government-bond volumes also stems from the fact that the Fed has bought trillions of dollars of the debt since 2008, taking it out of circulation.

Bond Hoard
The Fed is holding trillions of dollars of government bonds on its books and out of circulation
Source: Federal Reserve

But the way to fix that is not by encouraging banks to hold bigger pools of risky debt. That ultimately exacerbated the last crisis and inflicted deep pain on markets and the broader economy. One could argue that banks avoided deeper pain during the oil crash of 2014 because of these risk-curbing regulations. Hedge funds weren't so lucky and ended up going out of business at a steady clip.

Meanwhile, it's hard to see the direct line between better bond-market liquidity and materially improved prospects for the U.S. economy. 

Cohn, for his part, helped lead a bank that has been working hard to adapt to a more computerized, more-transparent market. And apparently, those efforts have been rather successful. As volumes surged in the fourth quarter of 2016, Goldman reported a 78 percent increase in year-over-year fixed-income trading revenues. During that period, investors sought to move around their portfolios, and plenty of traders were available to help them do so in an orderly fashion. Debt-trading volumes rose to record levels. (Goldman is also in excellent position to benefit from any rollback of the Volcker Rule.)

Stock Surge
Goldman Sachs's shares have risen amid hopes for less regulation and higher rates
Source: Bloomberg

Instead of opening the door back up to prolific and potentially dangerous proprietary trading, Cohn ought to be pushing for more transparency that'll assist traders in matching buyers and sellers, whether over the phone or through online marketplaces.The answer isn't to go back in time. It's to help the financial system move safely into the future.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net