The Volcker Rule: An Essential Reader

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Paul Volcker during his discussion with Bill Moyers. (Photo: Dale Robbins)

Earlier today, federal regulators approved the final version of the Volcker Rule, a piece of financial regulation that Wall Street’s lobbyists have fought hard to water down or eliminate. The rule, which was supposed to be finished by summer 2012, is central to Dodd-Frank and was conceived by former Federal Reserve chair Paul Volcker.

At a base level, it is intended as a replacement for some provisions of the Glass-Steagall Act, a law implemented during the Great Depression to keep commercial banks separate from their risky security-trading operations. The 1999 repeal of the act is often cited as precipitating the 2007-2008 financial crisis. But the Volcker Rule has it’s detractors on both sides, many on Wall Street think it goes too far while others don’t think it goes far enough.

Speaking with Bill Moyers in April 2012, Volcker explained the rule prevented banks from engaging in speculative trading with their customers’ money.

“It’s just kind of common sense,” he said. “The point is that this kind of trading affects the culture of the whole institution. And when it becomes important in the institution — when you’ve got some very highly paid people taking this kind of risk and speculating — people elsewhere in that commercial bank, traditionally conservative people, worried about credits and being careful say, ‘What’s going on here? I want to be better paid too and I want to take some more risk. Maybe I’ll make some riskier loans. And then they’ll pay attention to me.’ And it really is, I think, rather destructive of the culture of the institution.”

Here’s what we’re reading on the new rule which will go into effect on July 21, 2015.

The rule: Read the summary press release from the five agencies that have approved the rule and the text of the rule, or this handy primer from The Washington Post’s Wonkblog.

What the rule does and doesn’t include: “In some crucial areas, regulators adopted a harder line than Wall Street had hoped… the regulation includes new wording aimed at the sort of risk-taking responsible for a $6 billion trading loss at JPMorgan Chase last year. The rule also requires banks to shape compensation packages so that they do not reward ‘prohibited proprietary trading.’ In addition, it requires chief executives to attest to regulators every year that the bank ‘has in place processes to establish, maintain, enforce, review, test and modify the compliance program,’ a provision that did not appear in an October 2011 draft of the rule. But the rule, which aims to draw a line between everyday banking and risky Wall Street activities, has its limits. For example, the regulation leaves it largely up to the banks to monitor their own trading. Some critics of Wall Street also wanted chief executives to attest that their bank was actually in compliance with the rule, not just that it was taking steps to comply.”

Ben Protess and Peter Eavis in The New York Times

Why bother with this complicated rule? “In order to limit the government’s need to act as a safety net during a crisis, regulators are creating various tools that try to do three big things: First, the financial sector will have to internalize some of the costs of crises and insurance. Second, there’s more supervision of banks through things like capital requirements. Third, there are limits on the sorts of activities the banks can do. The Volcker Rule mainly focuses on the third component — it prevents banks from engaging in ‘proprietary trading,’ which essentially removes the parts of banks that gamble and act like hedge funds, because those parts can blow up quickly (see here for more). It’s also a conceptual and cultural shift: Banks need to be boring again and focus on their core business lines. As Marcus Stanley of Americans for Financial Reform wrote, the Volcker Rule creates ‘a new definition of the dealer or market maker role that is more stable and reliable due to the removal of proprietary trading incentives.’ This role will still support lending and credit but will also create a new ‘reliable utility role for dealer banks in the financial markets.'” [keep reading for six criticisms of the Volcker Rule, and why they’re wrong »]

Mike Konczal at WonkBlog

What if it isn’t strict enough? “Politicians and advocates — some Democrats, some Republicans — who blame the 2008 financial crisis on deregulation express concern that the Volcker rule won’t adequately block banks from making risky bets with their own money. If they deem the rule too weak, they say it will add fuel to a push to reinstate a Depression-era law known as Glass-Steagall that until 1999 split banks and securities firms. Such vows suggest U.S. lenders planning to challenge the ban in court risk a political backlash. A 2011 draft of the rule, required by the Dodd-Frank Act at the urging of former Federal Reserve chairman Paul Volcker, disappointed some politicians and organizations who wanted a stronger ban. Lawmakers already have drafted legislation.”

Phil Mattingly and Cheyenne Hopkins at Bloomberg News

What do the banks think? “Industry groups have argued that the rule… unnecessarily limits some safe forms of trading and will sink profits at some of the nation’s largest banks. They have called for broad exemptions, but the efforts were weakened when JPMorgan Chase lost $6.2 billion in the ‘London Whale’ trading debacle. In anticipation of the Volcker rule, many large banks, including JPMorgan, have shuttered or spun off their proprietary trading desks, as well as their private-equity arms and hedge funds. That could blunt the full force of the rule, analysts say. Still, bankers are leery of how regulators will define the buying and selling of securities on behalf of clients, known as market making. Another key concern among bankers is the deadline for compliance. Dodd-Frank calls for Volcker to take effect in July 2014, but analysts and industry groups anticipate an extension in light of the delays in finalizing the rule.”

Danielle Douglas in The Washington Post

What will the banks do? “Wall Street is preparing possible legal challenges to the Volcker rule due to be adopted on Tuesday, as some of the largest banks consider contributing to a fund to bring industry action against the controversial measure…. Some of the major banks affected by the rule – which bans banks from making bets on their own account, known as proprietary trading – may contribute to a lawsuit which would likely be brought by an industry trade group, those people said. If a legal challenge is pursued, it will probably be led by Eugene Scalia, a Gibson Dunn partner and son of US Supreme Court Justice Antonin Scalia. Mr. Scalia of Gibson Dunn has successfully sued regulatory agencies in the past.”

Gina Chon in The Financial Times
(registration required)

What’s next? Maybe rules governing equity markets and, specifically, high-frequency trading: “The main US securities regulator is facing fresh pressure to undertake a large-scale review of the rules governing the US equity markets following a call from another of the agency’s five main commissioners. Michael Piwowar, the newest of the five comissioners at the Securities and Exchange Commission, also became the third to call formally for a review of US market structure in recent weeks…. His comments are the latest in a series of calls made by other SEC commissioners such as Daniel Gallagher, a Republican appointee like Mr Piwowar, and Luis Aguilar, a Democrat, for the regulatory body to launch such a review…. A spate of high-profile glitches, such as the flash crash of 2010 where shares oscillated wildly in a matter of minutes and left regulators unable to reconstruct its causes for months, have raised concerns about the role of technology in financial markets.”

Philip Stafford and Arash Massoudi in The Financial Times.
(registration required)

John Light is a reporter and producer for the Moyers team. His work has appeared at The Atlantic, Grist, Mother Jones, Salon, Slate, Vox and Al Jazeera, and has been broadcast on Public Radio International. He's a graduate of Columbia Graduate School of Journalism. You can follow him on Twitter at @LightTweeting.
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