Volcker Rule just more ‘Big Brother’ banking, a failure of meaningful regulation
Former Federal Reserve Board Chairman Paul Volcker is shown at a 1980 Senate Banking Committee hearing. The Federal Reserve and the Federal Deposit Insurance Corp. each unanimously voted to adopt the so-called Volcker Rule, taking a major step toward preventing extreme risk-taking on Wall Street that helped trigger the 2008 financial crisis. The rule, which states that U.S. banks will be barred in most cases from trading for their own profit under a federal rule is named after Volcker, who advised President Barack Obama during the financial crisis. (AP Photo/Chick Harrity, File)
With the approval last week of the Volcker Rule, federal regulators have laid the foundation for a yet another Congressional attempt at creating a “Big Brother” state over banking. Unfortunately, this inept attempt will fail to hit the mark.
As one piece of the nearly 900-page Dodd-Frank puzzle, the Volcker Rule is the Hill’s rash prohibition on proprietary trading, a bank’s investment of their own money for profit. Unlike the massive impact and direct effects that subprime lending had on the global economy during the 2007 financial crisis, proprietary banking’s impact was indiscriminate. Is the activity risky? Sure, but so is driving a car or owning a gun, and neither of those basic human activities is banned. In fact, a lot of bank activity that actually falls in the category of proprietary trading is aimed solely at protecting against financial risk.
Banks often enter trades intended to protect against losses carried in a larger portfolio of their assets. While inherently risky, this hedging activity (referred to in the industry as “portfolio hedging”) reflects the banks’ goal of protecting their customers’ deposits and maximizing financial return.
Not unlike past excessive Congressional prohibitions in response to financial crises (see the enactment of Glass-Steagall, an act that severed all ties between investment and commercial banking after the Great Depression), the Hill has decided to prohibit portfolio hedging in light of the billions of dollars lost by J.P. Morgan Chase & Co. during the 2012 London whale trades. The nearly $6.5 billion loss was certainly a significant financial miscue and should raise eyebrows, but to enact a prohibition on such activity because of one bank’s failure is almost exceedingly flawed.
Furthermore, the new focus on portfolio hedging is an example of Congress’ lack of focus on remedying the problems that actually caused the 2007 financial crisis. Portfolio hedging is just one type of proprietary trading that was a single piece of the encyclopedic Dodd-Frank financial reform bill, yet has recently warranted immense regulatory attention due to a new and more recent financial calamity strewn about the headlines.
Rather than implementing a blanket prohibition on proprietary trading (a prohibition riddled with the need for further clarification and gaping loopholes), Congress should seek to more fully regulate financial institutions themselves. The Hill has a tendency to legislate against activity rather than institution, and such regulation is easily manipulated and erodes fast before possible benefits are enjoyed. One needn’t look far back in history — to the Great Depression again to see the Glass-Steagall Act and Congress’ determination to regulate activity (relationships between commercial and investment banks) rather than the institutions themselves.
If Congress seeks to better control Wall Street and truly address financial risk, they must make the tough decision to regulate Wall Street and not what Wall Street does. Legislation of that nature would certainly draw cries of “Big Brother” banking yet again, but at least then might Congress achieve its true goals of regulating Wall Street.
—
Mike Resnick is a third-year law student at Temple University Beasley School of Law and a 2013 Temple Law and Public Policy Scholar.
WHYY is your source for fact-based, in-depth journalism and information. As a nonprofit organization, we rely on financial support from readers like you. Please give today.