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Economy 4.0

Why mere mortals should know the name ‘Volcker’

David Brancaccio Feb 13, 2012

The high finance types these days are on the lookout for the name “Volcker” the way wary drivers in Maine are on the lookout for moose. Federal regulators are searching for ways to put what is called the Volcker Rule into force, as required by law. But there are reasons every American should also keep a eye out, whether or not they own or work for a financial company.

Paul Volcker used to serve as chairman of the Federal Reserve under President Reagan. He is generally regarded as an independent-minded fellow in the pocket of no one. When, after the great financial collapse of 2008, Volcker proposed that banks get banned for trading for their own fun and profit — instead of for their clients — this controversial idea was dubbed the “Volcker Rule.”

Today is the last day that interested parties can send letters to the government commenting on the Volcker Rule. Paul Volcker has sent a letter and an essay along with it. Yes, Volcker thinks the Volcker Rule is still a very good idea. His general position is that financial companies should focus on getting the job done for their customers and should be discouraged from making internal bets that have proven to be dangerously speculative in the past.

Volcker writes that the law is clear that government support for the banking system “can be justified only to the extent those institutions provide essential financial services.” By essential services, he means safeguarding deposits and providing credit to people and small and medium-sized businesses.  He makes it clear he does not mean proprietary trading, or activity that is “essentially speculative in nature — engaged in primarily for the benefit of limited groups of highly paid employees and of stockholders.”

Think of proprietary trading this way. Imagine you are looking for a real estate company to help sell your house. Would you be likely to do business with a firm that makes lots of money flipping, that is, rapid-fire buying and selling its own portfolio of houses? Or would you prefer a real estate company that makes money helping customers buy or sell their own houses?

Volcker says financial companies need to focus on the customers. Banks and other financial companies say the Volcker rule would raises costs for customers and hurt liquidity. Some liquidity is good, Volcker suggests, but ever more liquidity can encourage banks to take foolish risks.

Why should regular folks pay attention to this? Think about the last financial meltdown, the one from which we are just now digging out. This cataclysm affected all of us, whether or not we lost a job or a business or a home. That meltdown was caused by the bursting of a bubble fed by a frenzy of speculation. Paul Volcker believes his rule can throw some cold water on that frenzy and make the financial world a safer place.

Beyond the worry about liquidity drying up, financial companies believe the Volcker rule will drive business overseas to Volcker-less parts of the globe. And they say the rule is too complicated. It certainly does have a complicated name, beyond its spiffy nickname. Ready for the real name for this rule? Deep breath. “Prohibitions and restrictions on proprietary trading and certain interests in, and relationships with, hedge funds and private equity funds.”

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