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Is the Volcker Rule dead already?

Scott Jagow Feb 24, 2010

Last month, President Obama forcefully proposed an outright ban on “proprietary trading” at commercial banks. Standing beside him was former Fed Chairman Paul Volcker, an advocate of separating such risky investment banking activities from commercial banking. The Obama administration would invoke the so-called Volcker Rule, whether the banks liked it or not. Well, now, the Volcker Rule might be tossed aside, whether the president likes it or not.

From the Wall Street Journal:

Key senators are expected to scrap President Barack Obama’s proposal to prohibit commercial banks from certain risky trading activities, people familiar with the matter said, a setback for the administration’s bid to limit the size and scope of the largest U.S. banks.

…after resistance from lawmakers from both parties, Senate Banking Committee Chairman Christopher Dodd (D., Conn.) and other legislators are expected to introduce a plan next week that would give regulators more discretion to limit and potentially ban risky trading at banks, especially if it poses a risk to the broader economy. The measure would stop short of banning such trading outright.

Proprietary trading is done with a bank’s own capital purely for its own profit. From the Great Depression to 1999, it was not allowed at commercial banks because it didn’t involve the customers’ interests, but when commercial and investment banks were allowed to merge, prop trading became a part of commercial banking activity.

The White House insists it is still behind the original proposal to ban prop trading at commercial banks, but sources have been coming forward to suggest that the Volcker Rule is going nowhere or will at least be watered down.

This email from “a trusted source” was sent to economics professor Mark Thoma, who writes the Economist’s View blog:

Just saw your post on financial reform, and for what it’s worth, it wasn’t the Street that killed the Volcker Rule. It was the Senate. The Street (smartly, for once) largely hung back and let the Senate get rid of the Volcker Rule.

It’s a lot of inside baseball, but the way the administration proposed the Volcker Rule essentially guaranteed that it would never see the light of day. It royally pissed off the Banking Committee members, because they’d been working in pairs on a bipartisan bill for months, with no inkling that anything like the Volcker Rule was in play. There’s no way they’d ever agree to drop everything and revamp a key portion of their bill just to hand the President a political victory (on their political turf, no less).

There are those who argue that banning prop trading wouldn’t solve the problems that caused the financial crisis. They say limiting bank leverage is the key issue. But here we have another case of the president proposing “get tough” measures on the banks that he can’t get through Congress. Even the Consumer Financial Protection Agency appears on thin ice. MIT’s Simon Johnson puts it this way:

Naturally, the Obama administration’s generally weak and unfocused financial reform proposals have morphed into generally weak and unfocused congressional bills. The overall narrative has been lost – despite moments of clarity from the president…

Some limited change may now emerge from the Dodd-Corker compromise. I expect we’ll see a version of the “resolution authority” (giving gov’t the power to wind down banks), despite the fact this is a complete unicorn – a mythical beast with magical properties, but not actually useful in the real world.

Sadly, the consumer protection agency is likely to be gutted as the price of bringing Senator Corker on board. This is of course an affront to everyone who has been – and continues to be – ripped off by the financial sector. But we are where we are in terms of the blatant mistreatment of customers in this society. Business people often tell me that we need to “rebuild confidence” in this economy. I couldn’t agree more, but how does cheating people – and refusing to prevent others from cheating – lead to more confidence?

It doesn’t.

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