Volcker’s rule on rules

Oct 29, 2010 17:29 UTC

Former Fed chairman Paul Volcker has some advice for financial regulators writing rules to define new limits on banks’ ability to trade for their own accounts: be as vague as possible. At least that’s the message in this WSJ piece by Deborah Solomon (for which, to be upfront, Volcker declined to comment).

At first pass, that sounds a little nuts. If Dodd-Frank means to clamp down on proprietary trading at institutions that receive federal guarantees (like deposit insurance), then why wouldn’t regulations spell out, as specifically as possible, what those banks aren’t allowed to do? Solomon explains:

Mr. Volcker’s concern, according to several people familiar with the matter, is that narrow or prescriptive rules would invite gamesmanship on the part of banks and could allow firms to evade the rule’s intent. Already, some banks and their lobbyists are seeking to sway regulators and encourage them to narrowly define certain types of trading activities, according to government officials.

By being less specific, the logic goes, regulators will better be able to adapt to changing circumstances—and to banks’ tactics. Solomon compares this approach to the one the government already employs in the realm of money laundering. Another good example is insider trading law. It’s never been particularly clear what is, and what isn’t, insider trading. This can lead to bumpy prosecutions, but it does serve the important purpose of preserving flexibility. Leaving a fair amount of case-by-case judgment in the system lets regulators tap what Michael Polanyi called “tacit knowledge,” or the thing Supreme Court Justice Potter Stewart was getting at when he wrote of pornography: “”I shall not today attempt further to define the kinds of material I understand to be embraced within that shorthand description; and perhaps I could never succeed in intelligibly doing so. But I know it when I see it.”

In this Bloomberg column, Michael Lewis gives us reason to think this might be a good way to go. He writes:

The banks have no intention of ceasing their prop trading. They are merely disguising the activity, by giving it some other name. A former employee of JPMorgan, for instance, wrote to say that the unit he recently worked for, called the Chief Investment Office, advertised itself largely as a hedging operation but was in fact making massive bets with JPMorgan’s capital. And it would of course continue to do so. JPMorgan didn’t respond to a request for comment.

One conclusion: to have the best chance of ferreting out prop trading, regulators are going to need a lot of leeway in deciding what they go after.

Interestingly, though, Lewis comes to a different conclusion. He doesn’t opt for vague rules, but rather very strict, draconian ones that would change the face of finance more dramatically than most people probably imagine Dodd-Frank doing:

There’s a simple, straightforward way… to construe the Dodd-Frank language, and it would reform Wall Street in a single stroke: to ban any sort of position-taking at the giant publicly owned banks… If that means that Goldman Sachs is no longer allowed to make markets in corporate bonds, so be it. You can be Charles Schwab, and advise investors; or you can be Citadel, and run trading positions. But if you are Citadel you will be privately owned. And if you blow up your firm, you will blow up yourself in the bargain.

If you have little faith in regulators’ ability to keep up with Wall Street innovation* behavior and to use flexible rules to their fullest, then maybe Lewis’s approach is the smarter one. I’m sympathetic to that argument; I’ve voted to chop up overly large and entwined financial institutions before. But I don’t know if at this point that path is politically feasible. Dodd-Frank could have broken up the banks, but it didn’t. And I’m not sure that since the bill passed, the political clout of the be-tough-on-Wall-Street camp has grown.

Yet that camp is, admirably, still fighting. A group of senators, led by Carl Levin, recently wrote a letter to the new Financial Stability Oversight Council, urging regulators to really crack down and not let Dodd-Frank get watered down in the rule-making. It’s a good thing for people to hear, but so is Volcker’s message—that often the toughest rules are the ones that specifically prohibit the least.

*I regret having used this word, so I have gone back and changed it.


I think Volcker is broadly correct in insisting on a principles-based ban rather than a narrowly defined one. The clearer and more detailed the regulation, the easier it is for market participants to arbitrage it. The problem however with this idea is that ignores regulatory capture – If we had a constant supply of Paul Volckers to enforce the vague rule, I’d sign up for it. As Steve Waldman says here http://www.interfluidity.com/v2/215.html  : “An enduring truth about financial regulation is this: Given the discretion to do so, financial regulators will always do the wrong thing.”

Lewis is also correct in that the only way to make clear rules that cannot be gamed is if they are draconian as I argue here: http://www.macroresilience.com/2009/12/0 5/regulatory-arbitrage-and-the-efficienc y-resilience-tradeoff/

You’ve essentially hit upon why solving the incentive problem in banks via regulations is almost impossible. The only valid solution is to ensure that banks take their losses.

Posted by macroresilience | Report as abusive

Congress forces Bank of America to offer better service

Oct 19, 2010 19:03 UTC

Remember back when the big banks were telling us that re-regulating consumer finance with legislation such as the CARD Act and Dodd-Frank bill would severely disrupt the banks’ business models, and lead to horrible outcomes for ordinary Joes? Well, in Bank of America’s event-packed earnings call this morning, executives laid out how, exactly, the company’s consumer finance business has been forced to change in response to the new regulatory environment. From the press release:

As a result of the legislation and other changes in the environment, the company is changing the way its consumer bank does business, focusing on a relationship enhancement strategy designed to incent customers to bring more business and to make pricing more upfront and transparent. This change moves away from a dependence on penalty fees, which the industry had adopted over the years, and provides the customer with a better banking experience. These changes are expected to result in additional revenue.

So, let’s see. We’re getting 1) more transparent financial products; 2) better banking service; and 3) a boost to B of A’s bottom line. How could Congress have done this to us?!

Granted, the transition isn’t super-smooth. B of A would have reported a net profit today instead of a loss had it not been for a $10.4 billion “goodwill impairment” charge related to a new limit on how much the company is allowed to collect when people use debit cards at cash registers. (“Goodwill impairment” is a kind of made-up thing that you can read about here.)

And I’ll be the first to admit that “upfront and transparent” pricing might very well mean higher pricing, especially for people who are used to getting a free ride when it comes to financial services–like those of us who pay off our credit card balances each month, thereby borrowing at no cost. On CNBC this morning, B of A CEO Brian Moynihan was pretty darn clear: “Instead of charging penalty fees, we’ll charge monthly fees.”

Yet, as I’ve long argued, there is nothing wrong with that. If my bank wants to charge me for a service that I am receiving—credit card usage, paper statements, a low-balance checking account—why would I be upset? Just clearly tell me what the price of the service is, and then I’ll make a decision about whether or not I want to buy it. Old-fashioned, I know, but still so beautiful. I understand that many people continue to feel the effects of the recession, and that the idea of paying more for anything right now is a painful one. But, in the long run, it only seems fair that people pay for the services they get.

UPDATE: Kevin Drum digs this post, invoking Hayek along the way. Then one of his commenters smartly breaks things down according to demand elasticity.


I think it is excellent that BofA will now provide up-front fees. As a former banking employee, I can attest that customers always want the fees clear and concise, and they want to know what they are paying for. Unfortunately though, I think BofA will lose many consumers because they will now see exactly how expensive it is to bank there, and I believe BofA will lose revenues because they relied on these “fine print” fees.

Posted by Blackbird1996 | Report as abusive
  • Archives