Three and half years have passed, and the so-called Volcker Rule—which embodies some of the restrictions on banks that its namesake sought—is finally becoming a reality. In 2010, a bare-bones version of Volcker’s proposal was included in the Dodd-Frank financial-reform act. There then followed a seemingly endless process, in which the regulatory agencies sought comments from interested parties, and haggled internally, about how the rule should work in practice. On Tuesday, finally, the Securities and Exchange Commission, the Fed, and three other agencies voted to enact a seventy-one-page version of the regulation, which big banks like JPMorgan Chase, Bank of America, and Goldman Sachs will have to abide by.
In a statement, Volcker hailed the move, saying it has “put in place one significant part of the larger ongoing effort to rebuild a strong banking system fully capable of, and attentive to, meeting the critical financial needs of businesses and individuals.” Ben Bernanke, the current Fed chairman, acknowledged the lengthy delay in reaching this point. “Getting to this vote has taken longer than we would have liked,” he said in a statement, “but five agencies have had to work together to grapple with a large number of difficult issues and respond to extensive public comments.” Bernanke didn’t spell what he meant by “difficult issues,” but one of them has been that officials at the Fed disagreed with their counterparts at other agencies, particularly the Commodity Futures Trading Commission, about just how far to go in restricting the banks’ trading activities.
Having watched the saga unfold over the past four years—it was in late 2009 that Volcker first made his case to President Obama—I have mixed feelings about the outcome. On the one hand, it is encouraging to see the government reaffirming the basic principle that Volcker espoused. The trading desks of the big banks, in placing big bets on market movements, have been doing something that is far removed from the traditional role of commercial banks: lending to businesses and consumers, and helping clients manage risk. Even the most artful defenders of Wall Street have yet to come up with a convincing explanation for why these proprietary trading activities should benefit from a government safety net.
After such a prolonged delay, it is also reassuring that the political and regulatory system has, finally, reached a resolution. Once the financial lobby realized it couldn’t win the over-all intellectual argument, it settled on a policy of stalling and prevarication, hiring consultants and eminent professors to bombard the regulators with lengthy briefs defending the bank’s activities on an individual basis. At the same time, the banks pushed the regulators to spend several more years gathering information before they actually did anything.
Jacob Lew, the Treasury Secretary, deserves credit for pushing all sides to reach a resolution by the end of 2013, something that had seemed unlikely. Also worthy of a shout-out are Gary Gensler, the soon-to-be-departed head of the C.F.T.C., who stood up to some of the banks’ more self-serving demands, and Democratic Senators Jeff Merkley and Carl Levin, two of Volcker’s closest allies on Capitol Hill, who kept up the political pressure. In a joint statement, the two senators hailed the new rule, saying, “We fought for the Merkley-Levin provision of the Dodd-Frank Act in order to put a strong firewall between banks and hedge-fund-style high-risk trading. Today is a big step toward that goal.”
That’s arguably true, but there are still reasons to be concerned. If you spend some time reading the new rule and the nine-hundred-page background paper that the regulators provided, you will find a number of weaknesses in the new regime that the banks will surely seek to exploit.
The ban on proprietary trading still contains a great number of exemptions. It doesn’t apply to government bonds, including those issued by the federal mortgage agencies and by municipalities. If Goldman or Morgan Stanley want to short Treasury securities, or the city of Chicago, they can go right ahead. Also excluded from the restrictions are physical commodities, such as oil and gold, and spot foreign-exchange contracts. (Cue loud cheers on the commodity trading and FX desks at places like Citi and JPMorgan.)
There are also exemptions for market-making, in which the banks build up sizable positions in all sorts of securities, supposedly with the sole intention of having enough on hand to meet the demands of clients and for hedging risks taken elsewhere in the firm. But how can any outsider know whether a given trading desk is buying tech stocks, for example, to anticipate customer demand or to wager on the Nasdaq going up? The new rule fudges the issue, saying banks can build up positions to meet “the reasonably expected near-term demands of clients, customers, or counterparties.” What does “reasonably expected” mean? Your guess is a good as mine.
Hedging is also hard to pin down. When JPMorgan’s “London Whale,” Bruno Iksil, accumulated tens of billions of dollars in credit derivatives, the firm said he was trying to offset the banks’ over-all credit risks, but that turned out to be false. Wittingly or unwittingly, he was placing a huge bet on which way the bond markets would go. The new rule seeks to prevent this sort of thing by ordering banks to show that their hedging trades start out as efforts to offset specific risks, and to monitor the positions on an ongoing basis to make sure that this doesn’t change. (In the JPMorgan case, it appears, some of the Whale’s trades started out as actual hedges, but he kept doubling down.)
This bit of the new rule sounds pretty tough. Even here, though, a lot will depend on how the new regime is enforced. It will be up to the banks to create internal systems to monitor their various trading desks, and to provide monthly figures to the regulators about their risk limits, their profits and losses, and their inventory turnover. By July, 2015, each bank’s C.E.O. will have to publicly attest that the bank has a system in place that is “designed to achieve compliance.” This language represents a concession to the banks. Some regulators were reportedly in favor of forcing the C.E.O.s to attest that their firms were actually “in compliance.”
Even if the banks do comply with the rules relating to market-making and hedging, there are plenty of other ways for them to take risks. During the financial crisis of 2008, one of the things that devastated investment banks like Lehman, Bear Stearns, and Merrill Lynch was that, as part of the business of buying up subprime mortgages and converting them into marketable securities, they had accumulated on their balance sheets the “Triple A” tranches of too many junky C.D.O.s. Though not categorized as proprietary investments, these holdings were effectively big bets on the housing market. As far as I can see, and maybe I’m wrong, the new rule does nothing to prevent the banks from making similar wagers in the future. The background paper put out by the regulators says explicitly that “a securitization of loans, which would include loan securitization, qualifying asset-backed commercial paper conduit, and qualifying covered bonds, is not covered by section 13 or the final rule.”
Regulation is always a cat-and-mouse game. With their profits still depressed compared to the peak of the boom, the banks have an incentive to abide by the letter of the law while violating its spirit. Regulatory arbitrage and other forms of rent-seeking will flourish. If the banks can’t do what they want in the old ways, they will try to find new ways.
Having spent more than sixty years working in and observing the financial system, the eighty-six-year-old Volcker is well aware of this danger. In his statement, he said:
I look forward to a process, called for by the new regulation, in which the boards of directors and the top management of our leading commercial banks will cooperate closely in implementing the new rules within the institutions for which they are responsible. Appropriate internal controls and practical “metrics” for identifying proprietary trading are central to a workable and effective administration of the regulation. Equally, the supervisory agencies themselves will need to be equipped and alert in detecting and dealing with problems as they arise.
From Capitol Hill, Merkley and Levin pledged to do their part, too:
No regulation is ever perfect, and we will carefully monitor implementation and hold regulators and firms accountable. If problems emerge—for whatever reason—we will quickly press regulators to address them. Over all, though, the final rule looks improved over the proposal from two years earlier.
That sounds about right. But for all the reasons I’ve just listed, I’m giving the new Volcker rule two cheers rather than three.
Original Article
Source: newyorker.com/
Author: John Cassidy
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