Volcker Rule: Bastard Stepchild Of Lobbyists

Jesse Eisinger Dealbook February 24, 2012

Last week, it finally became clear that the Volcker Rule was as good as dead.

The Volcker Rule, named after Paul A. Volcker, former chairman of the Federal Reserve, is meant to bar financial institutions that are protected and subsidized by the federal government from trading for their own accounts. That is, it's pretty simple: Traders shouldn't speculate for their own personal gain using the money you and I pay in taxes.

Yet bank lobbyists with complicit regulators and legislators took a simple concept and bloated it into a 530-page monstrosity of hopeless complexity and vagueness.

They couldn't kill the rule. Instead, they are getting Congress and regulators to render it morbidly obese and bedridden.

Of course, that is no accident. The biggest banks, which are in business today only because taxpayers bailed them out, want to protect their valuable franchises.

"Most of the length, complexity and questions are in there because of industry lobbying," said Dennis Kelleher, who runs Better Markets, a financial regulatory reform group. The rule is "the bastard child of the lobbying industry," he said. "You can't demand and insist and lobby for all these rules and exemptions and then complain that it's too long and complex."

The banks are making sure the rule stays incapacitated. By Mr. Kelleher's count, of the substantive responses, 13 were pro-reform, compared with 300 from the industry.

The regulators and legislators deserve some sympathy against such an onslaught. But only so much. Responsibility for the gross inadequacy of the Volcker Rule lies with them. They added the loopholes and exceptions.

Regulators did so out of vanity. They are confident they will be smart enough to navigate all the complexities. Regulators have already testified that they wanted to carry out the rule in a nuanced fashion. They aspire to distinguish intentional proprietary trading from unintentional cases, a standard that is tantamount to pre-emptive surrender. That will make enforcement all but impossible without a trader stupidly putting something incriminating in an e-mail.

Even at this late hour, regulators still have a choice. The final rule is not in place. They could radically simplify it. The law could merely state that prop trading is illegal at banks backed by the government, and not explain what the inevitable exceptions and exemptions would be. And regulators could make sure to emphasize, in public pronouncements, that the penalty would be stiff. If regulators carried that through, banks would scream that the sky would fall "” that they wouldn't know what was legal and what wasn't.

Please.

What would happen is that regulators and financial houses would settle into a situation where only the most egregious violations would be prosecuted, while most acts that came close to the line would pass through. The result would be exactly the intent of the law: to reduce sharply any truly risky activities because lawyers would not be able to find rationalizations in any of the law's language. The Volcker Rule should be a lean and mean single sentence.

O.K., fantasy time is over.

Second-best is to introduce some bright-line rules into this monstrosity. Then Volcker would not be hostage to whichever heavily lobbied regulators happen to be on staff at any given moment.

As it stands, "it's as if we told the banks to stop speeding and required them to have speedometers," said a Congressional official familiar with the rule-making. "But we didn't set the speed limit."

Occupy the S.E.C., a group of reform supporters that wrote a powerful letter about the flaws and proposed remedies of the rule, has urged regulators "not to confuse mere complexity for nuance. Simple bright-line rules make the compliance process easier, both for the regulated and for the regulator."

Yes, bright-line rules set up an arms race between the law firms that figure out ways for banks to comply with the letter but not the spirit of the law, and the government cops that are trying to figure them out. That is a race that government can never win outright. But with some enforcement, regulators could prevent the worst risks.

In all their pages of concerns, what is the anti-Volcker crowd most worried about? Nothing convincing.

Banks and their industry groups have mainly argued that the rule would reduce liquidity, or the ease with which a customer can buy or sell an investment. Less liquidity would raise the cost of capital for those seeking it.

Bogus. There is a surfeit of liquidity on Wall Street. It generates fees and short-term gains but little social worth. It is the opposite of useful. It disappears when most needed, as in the "flash crash" of 2010, thus exacerbating collapses.

Trading has risen inexorably in the last couple of decades, but has that resulted in more companies raising cheaper capital? No. Indeed, Professor Thomas Philippon of New York University has found that the financial sector's costs to society have risen, not fallen, in recent decades.

Banks say the rule will hurt their market-making businesses. But as the Occupy letter points out, market-making is a competitive, profitable business. There is no law of nature that requires banks do it.

Regulators could, if they wanted to, ban all market-making by deposit-taking institutions. The Columbia economist Joseph Stiglitz and Robert Johnson of the Roosevelt Institute wrote in their letter (below) to regulators on the rule, "If absolute simplicity is truly what the industry demands, then the regulator should provide that."

Complex structures and high-risk trading should be eliminated, they argue. The rule, they point out, gives the regulators authority to make "any (their emphasis) limitations or restrictions" they want on trading, which includes banning all trading in securities or derivatives.

Despite the decibel level, the banks' case is weak. As Peter Eavis of ï?¦The New York Times noted on DealBook, the opposition comment letters substitute dire theoretical predictions for specific real-life examples. Surely, the banks have the data. If the data supported their case, why not trot it out?

The reason is that they didn't have to. They won anyway.

Johnson-Stiglitz letter

Jesse Eisinger is a reporter for ProPublica, an independent, nonprofit newsroom that produces investigative journalism in the public interest. Email: jesse@propublica.org. Follow him on Twitter (@Eisingerj).

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