Volcker Rule Explained…
As the provisions of the Dodd-Frank financial regulatory law begin to go into effect, federal oversight agencies have issued the first draft of the “Volcker Rule.” Named for former Federal Reserve chairman Paul Volcker, the Volcker Rule says that commercial banks shouldn’t be able to make risky bets with federally insured deposits.
- “The Volcker Rule seeks to keep activities essential to banking within a safety net, while excluding other, riskier, activities from this safety net. There are a variety of special regulations, and protections, banks get, ranging from federal deposit insurance (known as FDIC) to access to the Federal Reserve’s discount borrowing window, designed to keep the system working through panics. Banks currently engage in a wide variety of non-banking activities with safety net protection. For example, they speculate in currencies and run hedge funds and proprietary trading desks for their own benefit.”
- “Under a strong Volcker Rule, any securities market activities would have to be intended to serve customers—not market-making bets for the bank’s own profits. Prop trading is very common among the largest financial institutions, many of which were bailed out during the 2008 financial crisis, and among the firms that are targeted by Dodd-Frank. These large, systemically risky firms are also a big presence in hedge funds and private equity operations.”
- “The Volcker Rule helps with the conflicts of interest between banks and their clients. But it also provides for the stability of the economy as a whole. The financial system has the ability to disrupt a huge part of the economy in a panic. The Volcker Rule, by removing the “casino” part of the financial system from the core banking parts, will make panics less likely and more manageable when they do.”
- “There are two sets of concerns about the Volcker Rule that progressives should engage with. The first is that by moving prop trading from the banks to other entities those practices will become harder to regulate, and it will be more difficult to detect and stop harmful activities and more problematic to resolve when things go wrong. The correct way to deal with this is to require strong implementation of the rest of Dodd-Frank, especially when it comes to derivatives and hedge funds.”
- “The best way to create forward-looking regulations is to have clear boundaries and clear penalties. This makes it harder for financial instruments and practices to try and blur the line between the two, practices we saw undermining the New Deal financial regulations.”
- “The current rule is far too complex to carry this out. Even Paul Volcker has criticized the rule for its length and complexity. Instead of laying out “definitive bright lines,” Federal Reserve Governor Daniel Tarullo testified, the authors of the Volcker Rule designed it to take a “nuanced approach.” But, as Occupy the SEC argued in their comment letter, this will “confuse mere complexity for nuance” and that “simple bright-line rules make the compliance process easier, both for the regulated and for the regulator.”