The legislative headaches of the Volcker Rule

By Felix Salmon
January 25, 2010
Tracy Alloway has the transcript of the White House background briefing on the new, Volcker-inspired, banking regulations. And yes, they do require extra legislation:


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Tracy Alloway has the transcript of the White House background briefing on the new, Volcker-inspired, banking regulations. And yes, they do require extra legislation:

We want to take legislative steps. We will ask Chairman Dodd and Chairman Frank to supplement what is already in their bills with legislative steps that don’t just authorize but actually require regulators to prohibit one form of that risky activity, and that’s proprietary trading by firms that own banks. So it is a legislative step.

While there is an element of better-late-than-never here, there’s no doubt that this legislation really should have been included in the original House bill. Going back and asking Barney Frank to include a whole new set of rules and regulations after already having battled hard to get the present version through seems highly inefficient, at the very least.

And here’s the bit that Simon Johnson was so upset about:

The liability cap will be structured in such a way that it constrains future growth that leads to excessive concentration in our financial system. It’s not designed to reduce the share of any existing firm.

It’s designed to make sure that we don’t end up with a system that some other countries have in the world, in which there’s enormous concentration in their financial sector. So it’s designed to constrain future growth. It’s not about reducing liabilities within — the share within the existing structure…

The focus really is on making sure that in the future that firms don’t grow so concentrated that they would exceed this kind of cap overall on sources of funding. It’s designed to constrain future growth so that we don’t have the extent of concentration you see in many other major advanced countries in the world that were — resulted in way more devastating damage to those countries during the financial crisis even than occurred here in the United States.

In other words, the biggest US banks aren’t too big right now, we just want to make sure that they don’t get a lot bigger.

The problem is that the biggest US banks are too big. And being too big is not a relative thing, it’s an absolute thing. Yes, RBS was bigger, in relation to UK GDP, than any bank in the US — just as UBS was enormous relative to Swiss GDP. But JP Morgan Chase is bigger than either of them. And in a globally interconnected world of multinational financial institutions, it’s silly to give the biggest US institutions a pass just because they’re based in a large country. Essentially, the government seems to be saying “we’ve got lots of taxpayers, so we can afford to bail these institutions out if necessary”. But of course they can’t. And as a result, the liability cap should be set to prevent Goldman Sachs or anybody else from having a bloated trillion-dollar balance sheet. Such things aren’t necessary, and the systemic risk they pose is potentially devastating.

Since the Volcker Rule hasn’t even begun to be codified in the form of actual legislation yet, no one has much of a clue how much the ban on prop trading and internal hedge funds might reduce big banks’ balance sheets. But if you read the transcript, the Senior Administration Officials make no attempt to spin the ban as a way to shrink banks. Instead, they simply say that it’s not fair for banks to use their government backstop to get cheap funding for proprietary bets.

My feeling, then, is that the effect of this legislation on bank size will be marginal even if it passes — and that there’s a very good chance it won’t even get that far. I fear that in an attempt to gain the rhetorical high ground, the administration has only succeeded in giving itself yet another intractable legislative headache.

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