The Volcker Rule under threat

By Felix Salmon
November 5, 2010
Kevin Drawbaugh has obtained a letter from Spencer Bachus, the probable new chair of the Financial Services Committee, to Tim Geithner. And it turns out that Bachus is no fan of the Volcker Rule:

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Kevin Drawbaugh has obtained a letter from Spencer Bachus, the probable new chair of the Financial Services Committee, to Tim Geithner. And it turns out that Bachus is no fan of the Volcker Rule:

If the Volcker Rule’s prohibitions are expansively interpreted and rigidly implemented against U.S. institutions while other nations refuse to adopt them, the damage to U.S. competitiveness and job creation could be substantial…

I strongly recommend that your study of the Volcker Rule take account of how trading activities fit into the core business plan of global banks, as well as the consequences for U.S. banks and the banks’ clients of prohibiting those activities in the U.S. while they continue to be permitted everywhere else in the world.

This might well presage a significant weakening of the Volcker Rule, which curtails banks’ proprietary trading and tries to limit their growth, and was introduced into Dodd-Frank very late in the game, reportedly over the objections of the more technocratic members of the White House economic team, including Geithner himself. You might recall Geithner standing well off to the side, with a miserable expression on his face, the day that Barack Obama announced the rule.

You might also recall a letter that Geithner sent to Rep. Keith Ellison in January:

Finally, preserving the flexibility of the Federal Reserve and the other U.S. banking agencies to design and calibrate a leverage constraint for U.S. financial firms is essential to enable the agencies to successfully negotiate a robust international leverage ratio that works in all the major jurisdictions and does not leave U.S. firms at a competitive disadvantage to their foreign peers.

Clearly, Geithner is sympathetic to arguments which worry about putting US banks at “a competitive disadvantage” globally: he’s made them himself. And equally clearly, the Volcker Rule is little more than an expression of intent at this point: if Geithner and Bachus decide to render it toothless, they almost certainly can.

But of course the explicit thinking behind the Volcker Rule is that there are good and bad ways for a bank to become globally competitive. The bad ways involve taking unnecessary risks with taxpayer money. The point of the Fed’s discount window is to provide a funding source for banks to make loans into the broad economy, not to provide a near-zero cost of funds for proprietary bets. And no bank in the world will deliberately cross-subsidize its lending operations with its prop-trading profits.

Shuttering prop desks, writes Bachus, “will cause these firms to be less profitable”. Well, yes. That’s a feature, not a bug. We don’t want financial institutions to be profitable: they’re middlemen, and their job is to help capital flow to where it can best be put to work, rather than to retain as much of that capital as possible for themselves, in the form of profits and bonuses.

But I fear that Geithner is sympathetic to Bachus’s points. Could this be the beginning of the end of the Volcker Rule?


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When push comes to shove, who is the GOP loyal to? – Its voter, or the banks who financed its campaign?

GOP leaders should know that many people who voted for them are rather skeptical about their integrity and capabilities, and will be watching every move they make in the next 18 months.

Posted by yr2009 | Report as abusive

@yr2009 — The GOP has its ties to big banks, I totally agree. But this idea that the GOP is the main participant in the Wall Street lovefest is the fallacy that will not die.

The whole NY delegation in both houses is Democrat. Democratic king Charles Schumer (who almost was the next majority leader) is Wall Street’s big man in Congress, and he spread banker money to Dems from sea to shining sea.

As Ritholz has lamented, we got fake reform. Gee, who write this gentle reform?

Posted by DanHess | Report as abusive

Someone needs to point out to Congress and the Treasury what prop desks, hedge funds and flash trading are doing to the financial markets: Creating the biggest casino in the world.

Here are some salient points that are facts, not exaggeration.

1) Program trading throughout 2009 constituted over 50% of the daily volume on the NYSE. Among those program trades, Goldman was nearly 80%. Who wants to ‘invest’ their money in a market rules by day traders? No one. No wonder the equity markets still see the fewer and fewer investors.

2) Leverage is the catalyst of all boom/busts and should be strictly controlled by the Fed. FX traders can still leverage 10 to 1 (and higher); hedge funds still do naked shorts; margin requirements on bonds is way too low. The Fed should raise margin requirements across the board on equities, bonds, futures, FX trading, etc.

3) Tax Code: The lowest tax rates in the US Federal Tax Code is given to index options writers. They only pay 10% tax rate on their premiums from writing these contracts. Think about that. One of the most speculative trades is awarded the lowest tax rate. Furthermore, short term tax rates should have brackets for 24-hour trades (tax these at 90%), anything under a year (tax these at 70%).

Posted by Acetracy | Report as abusive

If they want to pack it up and move let them. Maybe it won’t be so cozy away from Wall Street, and no Americans will want to do business with them either. I say good riddance. Let them go ruin someone else’s economy.

Posted by scrypton | Report as abusive

Penultimate paragraph is extremely well put. Saying that rule change X will likely result in lower profits for the banks is not in itself an argument against X. I mean, cracking down on monopolies tends to result in lower profits for monopolies. I know that not all profits represent win-lose economics, but in the case of the banks over the last twenty five years there is good reason to believe that their gain has indeed been our loss: they’ve been profitable precisely because they’ve externalized the cost of risk onto the taxpayer. As their primary function is, when you boil it down, risk-assessment, this is a pretty substantial shortcoming.

Posted by Kaitain | Report as abusive

#1. Increased capital requirements are very needed and positive.

#2. Ditto increased liquidity requirements

#3. Also a pretty good idea to move derivitive trading to some kind of exchange. Transparency makes problems easier to spot sooner rather than later (as was the case with AIG)

Beyond that why on earth would you want to limit the financial activities of “banks.” Citi use to be in the business of speculating in the oil markets to the extent that at one point it had dozens of super-tankers chartered and filled with oil waiting for the price to rise. That made them a profit and when private sector demand for oil increased there were additional barrels to sell (presumabley lowering the market price at the time of the sales.) That strikes me as a valuable servivce to the broader economy. Others may disagree.

Private equity, venture capital, hedge funds… these all serve a function or they would not exist. Why stop banks from offering services in these areas if adaquite capital is held in reserve?

Posted by y2kurtus | Report as abusive