Paul A. Volcker is a giant of financial history. He played a behind-the-scenes role when the United States abandoned the gold standard in 1971. He restored credibility to the Federal Reserve and slew inflation a decade later.
Paul A. Volcker, here testifying before the House Banking Committee in 1980, restored credibility to the Federal Reserve as its chairman.
Go to your Portfolio »
In what would have been retirement years for anyone else, he became chairman of the group overseeing the International Accounting Standards Board and guided it to a level of independence that outraged French banks.
Now, at 83, he finally has something named for him. The question is whether it can be effective.
The Volcker Rule was part of the Dodd-Frank Act that Congress passed last year, barring banks from engaging in “proprietary trading.”
When Mr. Volcker proposed it, the big banks at first wanted to kill it. But it became clear that the combination of his prestige and the bank’s own bad reputations meant that something was going to pass.
So the banks settled for trying to hobble the rule with exceptions and qualifications.
Now it is up to regulators to adopt rules.
This week the Financial Stability Oversight Council, which was also created by Dodd-Frank and is led by the Treasury secretary and includes other financial regulators, put out a study and recommendations on the issue, providing at least a road map toward the rules that will come out within a few months.
The hurdle they face is simple: there is no easy way to tell a proprietary trade from another kind of trade, particularly given the exemptions worked into the law.
As the study noted on its first page, “These permitted activities — in particular, market making, hedging, underwriting and other transactions on behalf of customers — often evidence outwardly similar characteristics to proprietary trading.”
To some extent, regulators have made it easier for banks to continue trading. The biggest potential loophole is market making, and the study took a broad view of that. It made clear that market makers may acquire securities because they expect customers to want them, not just because they already have orders.
That means, wrote Jaret Seiberg, an analyst with MF Global, that they “need not worry that miscalculating customer demand would result in large penalties.” He added that “this seems even more positive than industry was expecting. The biggest banks would benefit the most from adoption of this type of proposal.”
But that goody may be more than balanced by the overall tenor of the report, which repeatedly cautions that regulators must be on the outlook for efforts to evade the rules.
“I think it is a good-faith effort to enforce what the law asks for,” Mr. Volcker told me this week, after reading the report. “It makes clear you cannot hide proprietary trading in other activities. It strikes me as very straightforward.”
Straightforward may not be the word that some bankers will choose. They had hoped for clear rules that could be complied with — or evaded, if you want to be cynical. Instead, they got a lot of advice for regulators on how to monitor bank trading to see if it complies, using statistics invented for other purposes, like risk measurement.
Do banks tend to make the most money from a trade on the first day, rather than over time? Does the inventory of securities turn over quickly? Are daily profits relatively consistent? Negative answers could indicate proprietary trading and provide a reason for bank examiners to descend on a trading desk.
I have another metric that they might consider. What are the traders paid? If a trader is collecting millions in salary and bonus, you have to wonder whether he or she is merely trying to satisfy customer demand, as opposed to time markets.
The use of all those metrics, along with requirements for banks to monitor them and have clear policies, sounds scary to some. Winthrop N. Brown, a partner at Milbank, Tweed, Hadley & McCloy who represents banks, said the council had done a good job in general, but “I would be troubled if I were a chief compliance officer. It seems to be very burdensome.”
The Sarbanes-Oxley Act in 2002 accomplished something with a provision that I thought superfluous, and the council picks up on that by suggesting that chief executives be required to certify that their banks are in compliance with the Volcker Rule, just as the earlier law forces them to certify the accuracy of financial statements. It turned out that certification concentrates attention, even if it does not change the underlying legal requirements.
Floyd Norris comments on finance and economics in his blog at norris.blogs.nytimes.com.
Read Full Article »