Updated Volcker Rule Published
Last night was a fairly news-worthy evening. In addition to Greece and Spain’s surprise bond issues, the text of the much discussed Volcker Rule was sent to Congress by the White House.
So how does it differ from the initial proposal that has been discussed endlessly, including on this blog?
- The bill does regulate non-bank holding firms (hedge funds, private equity, and probably sooner rather than later, Goldman and Morgan Stanley) by imposing “capital and quantitative limits” on these firms, but does not go so far as to allow them access to government funds in the event of systemically-risky collapse.
- Firms are prohibited from assuming by acquisition more than 10% of all liabilities in the system. This is a change from current rules which prohibit firms from owning more than 10% of deposits, and is a reflection of the move towards retail deposits being a smaller and smaller piece of the funding that banks use to do their business.
I made it clear in an earlier post that I was not a huge fan of the proposal as it was initially laid out. For an even better write-up of some of the issues, see Economics of Contempt’s excellent writeup. However, I do feel that while the addition of these two rules do make the Volcker Rule stronger, it still leaves critical holes unplugged.
The largest hole here is that it still implicitly assumes that non-retail banks are not systemically important. Lehman Brothers conclusively proved that they in fact can be. The updated Rule imposes some restrictions on these firms (though what the specific “capital and quantitative limits” will be has yet to be clarified), but doesn’t go so far as to acknowledge that 1) these firms most certainly can be systemically important and 2) in the event of collapse of a systemically important investment bank or hedge fund, it’s going to need to be bailed out anyways lest we have a repeat of Lehman.
Furthermore, the moral hazard has already been breached, and I think that the market generally understands that these firms will be bailed out in the event of another meltdown. Why not codify this, put into place resolution authority, and make it well known the process by which these firms will be wound down?
I also have yet to see a good definition of what will constitute proprietary trading. This is a hard nut to crack, as the firm can trade onto it’s own book for many a legitimate customer transaction. It’s hard to separate this out. Making broad statements about banning it is fine, but actually enforcing it can get hairy when regulators try to determine what was legitimate vs what was not. I imagine that defining this will be an ongoing process, but it still needs to be addressed.
My final issue, and one common to almost any law, is that the language appears to be less than clear. Dealbook has quotes from several business and finance professors confirming what many have feared–that it will likely be easy to circumvent the rule through loopholes. I’m not an expert on the legal text by any means, but systemic financial regulation is too important to pass cursory rules that can easily be circumvented.
In the end, my feeling is still the same–the bill’s heart is in the right place, but it just doesn’t get it. It’s a good first start, and includes some solid points, but I haven’t yet seen enough that says to me that Congress and the White House are doing much more than making cursory attempts at regulation that address the symptoms, not the causes of the financial crisis. I hope to be proven wrong.
