Where Is The Volcker Rule?

By Simon Johnson

Three years ago, a financial crisis threatened to bring down the United States economy – and to spread economic disaster around the world. How far have we come in preventing any kind of recurrence? And will the much-discussed Volcker Rule – attempting to limit the risks that big banks can take – play a positive role as we move forward?

Bad loans were the primary cause of the 2007-8 financial debacle. When the full extent of the problems with those loans became apparent, there was a sharp fall in the values of all securities that had been constructed based on the underlying mortgages – and a collapse in the value of related bets that had been made using derivatives.

The damage to the economy became huge because these losses were not dispersed throughout the economy or around the world. Rather, many of the so-called “toxic assets” were held by the country’s largest banks. Financial institutions that used to lend to consumers and businesses had instead become drawn into various forms of gambling on the booming mortgage market (as well as on commodities, equities and all kinds of derivatives). “Wall Street gets the upside, and society gets the downside” was the operating principle.

And what a downside that proved to be. Treasury Secretary Henry Paulson said the Troubled Asset Relief Program, or TARP, was needed to buy those toxic assets from the banks. But this quickly proved unwieldy, so TARP pumped roughly half a trillion dollars into bank equity. The Federal Reserve backed this up with a massive amount of “liquidity” through more than 21,000 transactions.

The additional government debt as a direct result of this finance-induced deep recession is estimated by the Congressional Budget Office at around 50 percent of gross domestic product, roughly $7 trillion.

These are staggering numbers. And this system of big banks taking outsized risks, failing and imposing huge damage on the rest of us has to stop. This ball is now firmly in the regulators’ court.

Whatever your broader issues with the Dodd-Frank Act of 2010, one point about legislative intent in this legislation is clear: the regulators have the authority to cut banks down to size and return them to their historical role of intermediating between savers and borrowers.

As for size, the regulators have long ignored the existing guidelines and allowed the biggest banks to get bigger. We need to go in the opposite direction, and that includes cutting the private mega-banks, as well as Fannie Mae and Freddie Mac, down to size. It also means taking advantage of the resolution authority and all associated provisions that Sheila Bair, the former chairman of the Federal Deposit Insurance Corporation, worked so hard to put into the Dodd-Frank Act.

As Jon Huntsman is arguing on the Republican campaign trail, too-big-to-fail banks simply need to be forced to break themselves up.

But we also need to make the mega-banks less likely to fail. The easiest way to do that would be to require banks to have enough common equity to absorb losses.

But the bankers have pushed back hard, with Jamie Dimon, head of JPMorgan Chase, leading the way with statements such as this on capital requirements, which are known loosely as the Basel Accords: “I’m very close to thinking the United States shouldn’t be in Basel any more. I would not have agreed to rules that are blatantly anti-American.”

Dan Tarullo, responsible for this issue on the Federal Reserve Board, seems to support the idea of requiring significantly more equity in big banks, perhaps moving in the direction recommended by Anat Admati and her colleagues. But Mr. Tarullo appears to have lost that battle for now.

If we are not breaking up banks and if we are not requiring them to have reasonable levels of capital (thus limiting how much they can borrow relative to their equity), we must use all other available tools to stop the too-big-to-fail banks from taking excessive and ill-conceived risks.

This is where the Volcker Rule becomes so important. Named for Paul A. Volcker, former chairman of the Federal Reserve, and adopted as part of Dodd-Frank at the insistence of Senators Jeff Merkley, Democrat of Oregon, and Carl Levin, Democrat of Michigan, the Volcker Rule directs the regulators to get banks out of the business of betting on the markets.

The regulators are now determining how they plan to implement it. Draft proposals are currently open for comment.

But the latest news on this front is not encouraging, as key regulators seem stuck in a “bigger is better, and anything goes for the biggest” mindset.

The Volcker Rule has some good points, including a requirement that trader compensation not be tied to speculative risk-taking, and that firms collect and report some essential data to regulators. But the current draft does too little to actually stop the banks’ current risky practices.

The main problem is that the rule as drawn does not set out the clear, bright lines that banks and regulators need, nor does it provide for meaningful enforcement. Instead of drawing the lines, the proposed rule mandates that firms write many of the rules themselves.

There is some good news. At this point, it is only a proposed rule, and it is open for comment (submit a comment here).  Organizations like Better Markets that promote the public interest within the regulatory process will be in there fighting to strengthen the proposed rule and make the final rule better.

Everyone who cares about real financial reform should do the same, but the regulators’ draft rule has made it harder to uphold the public interest than should have been the case. For example, the regulators ignored the breadth of the Volcker statute and focused instead only a narrow slice of the bank’s balance sheet – just what the bank says is for “trading” purposes. Much else of what big banks do seems likely to escape scrutiny.

The regulators also have given very little guidance on conflicts of interest, on what should be considered high-risk assets or on what high-risk trading strategies should be permitted.

During a Senate hearing at which I testified last week, Senator Bob Corker, Republican of Tennessee, focused on another important problem – the lack of any restrictions on trading in the enormous Treasury securities market. The regulators will create a lot more paperwork for the banks, but if the current draft is adopted, the too-big-to-fail banks are not likely to be forced to stop doing much.

Last year Senator Levin said:

“We hope that our regulators have learned with Congress that tearing down regulatory walls without erecting new ones undermines our financial stability and threatens our economic growth. We have legislated to the best of our ability. It is now up to our regulators to fully and faithfully implement these strong provisions.”

From what we’ve seen so far, our regulators have not yet understood this message. They seem instead more in tune with Mr. Dimon, who insisted earlier this year that regulators should back away from any effective implementation of the Volcker Rule:

“The United States has the best, deepest, widest, most transparent capital markets in the world which give you, the investor, the ability to buy and sell large amounts at very cheap prices. I wish Paul Volcker understood that.”

Mr. Dimon — who is on the board of the Federal Reserve Bank of New York — seems to have forgotten the financial crisis, its impact on ordinary Americans and the utter fiscal disaster that ensued. Or perhaps he never noticed.

Mr. Dimon seems to have forgotten the financial crisis, its impact on ordinary Americans and the utter fiscal disaster that ensued. Or perhaps he never noticed.

An edited version of this post appeared yesterday on the NYT.com’s Economix blog; it is used here with permission.  If you would like to reproduce the entire column, please contact the New York Times.

26 thoughts on “Where Is The Volcker Rule?

  1. We’ve now lost one of those very distinguished street lamps like you might see in Britain, guiding you back home through the confusion of society. A man who put deep thought into things and tried to get the correct answer to life’s questions and not the quickly computed wrong answer. Although I didn’t agree with him on everything, no one can doubt his logic and extremely rational mind.

    Now the remaining (though maybe not yet quite as distinguished) lamps the light us on our sometimes dark journey have to work twice as hard now that that lamp has flickered out. And what a great way to start with the reinstallation or rebooting of the Volcker Rule.

    Come on James and Simon!!!! We’re counting on you to pick up the slack for Mr. Hitchens.

  2. Americans are well known for eventually doing the right thing. They just -try- everything else first. I believe this to be no different as we have already crossed the point of no logical financial return, with the exception of a few heads rolling, and the time police of course.

  3. Simply a central bank hilarious riot:

    Thanks to the latest commentaries by Brady Willett of Fall Street, Tom Szabo of Metal Augmentor, and Jim Willie of the Golden Jackass, more people are realizing the potential for market manipulation through central bank gold leasing, of which there lately have been strong indications.

    In “Did Ron Paul Slay the Gold Bull?” Willett remarks that favorable lease rates “allow powerful interests to more readily manipulate gold”:In “Charlatan Exposed: Negative Gold Lease Rates,” Szabo writes: “The gold forward rate has increased during both the late September and current selloffs in gold, which probably means that gold is being leased by central banks in order to provide liquidity for the banking system. … The gold bugs are essentially right that the gold price is falling this time because paper gold is flooding the market.”Szabo seems to concur with GATA’s interpretation of the London Bullion Market Association as a fractional-reserve gold banking system generating a lot of imaginary gold for price-suppression purposes. He writes: “Other than the use of unallocated gold for swap, collateral, or trading purposes, the only other reason why an owner of gold would seek to ‘deposit’ physical gold with an LBMA member in an unallocated bullion account would be to avoid storage fees associated with allocated gold. It is not known to what extent the LBMA unallocated account is used by customers to avoid storage fees, but a significant amount of gold, perhaps several thousand tonnes, has been converted to paper form as a consequence of the bullion banks’ business. The theoretical result is that the paper gold will have to be converted back to physical metal in the future when the customer requests a withdrawal. We say ‘theoretical’ because the gold market may not be able to handle mass withdrawal requests from unallocated account holders should a future monetary crisis make all counterparty risk untenable. In fact, mass withdrawal requests would probably lead to a default in those LBMA unallocated accounts that are not backed by physical metal. At the present time, that would be most if not all of them.”

  4. Pressure still has to be brought against the banks and those regulators and politicians in their pockets – but let’s not pretend this is all something new. The Great Depression wasn’t triggered, but it’s appearance was signaled by the crash of ’29 which happened in October of that year. It wasn’t until June of 1933, almost four full years, and a Congressional and Presidential election later when any of the legislation to control the markets was put in place. We look back and say, “After the Crash of ’29 they put in Glass-Steagall, Created the FDIC (part of Glass-Steagall), passed the Securities Act, created the SEC etc., etc. and yet is seems like we’ve done nothing along those lines. But it still took years, and overcoming the fierce fighting of Wall Street to get those laws passed. We have passed Dodd-Frank and it does many things, the Cosumer Protection and the Volker rule being most valuable in my view, but of course the big banks are going to fight against it. Even FDR’s policies that we now all laud as protecting the common man, were viewed by many at the time as giving in to corporate and Wall Street interests. Here’s Father Coughlin in 1936:

    “The great betrayer and liar, Franklin D. Roosevelt, who promised to drive the money changers from the temple, had succeeded [only] in driving the farmers from their homesteads and the citizens from their homes in the cities. . . I ask you to purge the man who claims to be a Democrat, from the Democratic Party, and I mean Franklin Double-Crossing Roosevelt.”

    This was AFTER creation of the FDIC, and the SEC. In my view if the Bernie Sanders of the world think these laws and their regulations are give aways to Wall Street and the John Kyl’s of the world think they are going to destroy American business, then we’ve got a pretty good set of rules. So we shall see.

  5. “Bad loans were the primary cause of the 2007-8 financial debacle.”

    But were they?

    I don’t know – it seems akin to blaming a nuclear meltdown on an earthquake when the fact is you built the reactor on a fault line and actively subverted the protections.

    It’s like leaving piles of fireworks out and then blaming the explosion on an accidental spark.

    It’s like blaming the failing tire for death of the guy driving 120 mph in a 30 zone.

    The point is they built this house of cards on a rotten foundation – sure lots of nasty loans, but then they built derivatives, and CDSes, and tranches, other unholy financial instruments of mass destruction on it, and fed it all back into our retirements and 401ks. Oddly enough when the loans blew, the massive pile depending on it went with it too.

    Sure, maybe the tire should have been better engineered, but driving 120 mph was far stupider.

  6. Prof Johnson, “These are staggering numbers. And this system of big banks taking outsized risks, failing and imposing huge damage on the rest of us has to stop. This ball is now firmly in the regulators’ court.”

    I’m just speculating here, but I think there may be a difference in opinion about what kind of *regulator* is needed at this point.

    And please stop cherry-picking a snippet of the timeline to make a point about how long it’s going to take…you are dumping 7 billion diapers off every 24 hours – LIFE MAINTENANCE is a daily cycle, not 4 years while maladjusted *isms* are corrected….they got corrected – if you continue down the time line – with WWII. Which means taking 4 years to write a new rule down is probably not a GOOD thing to emulate.

    Winter’s here – nor’easter of 1996 (one of 18 major snowstorms in NYC that winter season) – DAILY food delivery came to a halt because of overwhelming regional snow pack – NYC emergency managers noted that Manhattan Island ran out of farm delivery food in 3 days…time lines FOR LIFE MAINTENANCE COMMERCE is a 24 hour cycle.

    Considering how many world class chefs there are in NYC catering to 1% elite hedonists – no problemo – rats ala orange with a side order of refried stink bugs, cockroaches and bed bugs – yum.

    Do you guys have 4 more years to yaddayadda? A LOGICAL question…

  7. Did somebody not read of the, end of times, in the Bible? And how when that day came you would not want to be elderly because of the treatment you would receive. Oh yea, we call that throwing grandma out on the street, and finding ways to cause just financial wars from it. Toochee!

  8. @Anonyomousy – The historical account of Rome taking Israel down a notch or two (Israel’s *end times*) is NOT about the future – get over yourself. Pharisees who *ruled* Israel 2,000 years ago were always throwing Grandma out on the street – their justification/righteousness for doing that to her is probably also in your bible…oldest trick in the book to *lay hands* on property – somewhere on the historical timeline between p_ssing on it to mark it as yours and today’s MERS fraudclosures…

    So why are you on a economic blog if the world is ending….?

  9. “Where is the Volcker rule?” asks Prof. Johnson, who gives an attenuated account of its journey from vague reformist hankering to vague provision in Dodd-Frank, currently being made less vague by all the usual suspects determined to prevent any serious interference with the profitable ways of big capital. As many on this website pointed out at the time of its proclamation, the Volcker Rule, in any of its multiple iterations, was DOA, owing to the current balance of political (class) forces in the U.S.A. We were/are being vindicated; while Prof. Johnson is simultaneously counting his Confederate money, as it were, and wondering where it might be accepted as legal tender. The short answer to Johnson’s question: The Volcker rule has gone to wherever reformist notions of having-our-oligopolistic-corporate-capitalist-cake-while-eating-it-too (with reforms) “go” when their shelf life is up; namely, back into the Next Time Will Be Different box of false promises endlessly recycled by well-intentioned reformists such as Johnson. (If he had asked, Where has “change we can believe in” gone? the answer would be generically identical.)

  10. Slammed the *middle class* – financially – into a PERMANENT manufactured poverty through the machinations of Global Criminal Inc. (war lords, drug lords, slave lords) That is what was achieved with *regulation*…

    It’s a war now.


    “Force may be used only after all peaceful and viable alternatives have been seriously tried and exhausted or are clearly not practical. It may be clear that the other side is using negotiations as a delaying tactic and will not make meaningful concessions.”

    700 trillion in *derivatives* being accepted as *real* commerce currency….?!

  11. I think you give yourself too much credit. Force and war rarely end good, peace and a meeting of the minds thru intelligence is the recommended school of thought. Your level of consciousness is lacking and your approach to resolving the difference leads you to justify a war in your own mind. Gather up a flash mob of high school friends and you have brigade of bullies. But, unbeknownst to you, there is always a bigger bully or bigger drug lord, or even a meaner slave lord, that gets between you, and the truth.

  12. @Anonyomousy – Wow! Feel more superior now?

    Having a conversation organized around the *Just War* criteria is NOT a sign of *intelligence* in your mind?

    Let’s just go off like we did to Iraq based on LIES fed to us by war lords and drug lords and slave lords and now next up – Iran?

    Shouldn’t the Shia and Sunni have a go at meeting each other’s minds without sucking out USA blood and treasure?

  13. You make it sound as if i’m a federal man or something, After 3 years on this blog I’m certain it was Annie that caused the negative rates and ruined the economy. And it had to have been you, that refused suzie’s financial independence, after which she then cried a river that drowned the whole world. And it might even have been YOU that helped those irresponsible parents take their children’s future away. Oh yes, you will be held liable for the consequences one day, but of course not soon enough for me. Wow, I think I just climbed a step on jacob’s ladder, hows about you?

  14. cut banks down to size and return them to their historical role of intermediating between savers and borrowers […] the Volcker Rule directs the regulators to get banks out of the business of betting on the markets.

    Here is the cognitive dissonance behind the Volcker Rule idiocy in a nutshell.

    Mr. Johnson, as you know a loan is an asset that is subject to market forces. So if you want banks lending to borrowers, then you do so want them ‘betting on the market’. If they have made any loans at all, they have made a bet on the market. At the very least, they can’t possibly ‘intermediate between savers and borrowers’ without a maturity mismatch that is (drumroll) affected by market forces. I also wonder why everyone seems to ignore that all loans contain risk – credit risk, rate risk, etc. – when spouting off about how they ‘don’t want banks taking risk, they just want them making loans’.

    If you don’t want banks betting on the market, you don’t want them lending. If you do want them lending, by definition you want them taking risk, and thus you might do well to consider that the entire philosophy behind the Volcker Rule may in fact be 180 degrees wrong.

    You complain that the current draft rule doesn’t ‘does not set out the clear, bright lines’ and ‘have given very little guidance on conflicts of interest, on what should be considered high-risk assets or on what high-risk trading strategies should be permitted’. Mr. Johnson, I am here to tell you that this is because there are no such ‘bright lines’, nor clear definition of ‘high-risk’, and any attempt to draw them will inevitably descend to a spaghetti mismash of arcane rules as illustrated here,/a>. That sort of rule will surely pay a lot of lawyers, auditors, and compliance specialists. But it will not solve any actual problems.

    It is perfectly fair to lament that banks that took risks and lost were bailed out by taxpayers. The error lay in those bailouts. The solution is to eschew bailouts. But the Volcker Rule compounds error upon error by tacitly taking bailouts for granted and then futilely attempting to technocratize the problem of what constitutes ‘ok’ trading and risk-taking. The financial sector will happily play along and co-write the rules and join in with the public pronouncements as to how much these regulations improve things. That does not mean the rest of us have to.

  15. I think Alan Greenspan should be brought in to this debate:

    Seriously, Simon, you should organize a round-table discussion with Charlie Rose or someone like that with you, Alan, Jamie, and hash it out.

  16. Following up on the remark that Alan Greenspan should be brought in to this debate and Mr. Dimon insisting earlier this year that regulators should back away from any effective implementation of the Volcker Rule, saying:

    “The United States has the best, deepest, widest, most transparent capital markets in the world which give you, the investor, the ability to buy and sell large amounts at very cheap prices. I wish Paul Volcker understood that.”

    I wish to quote Alan Greenspan in the Financial Times (March 30, 2011):

    “The problem is that regulators, and for that matter everyone else, can never get more than a glimpse at the internal workings of the simplest of modern financial systems. Today’s competitive markets, whether we seek to recognize it or not, are driven by an international version of Adam Smith’s “invisble hand” that is unredeemable opaque”.

    Alan Greenspan had already voiced this opinion in his 2007 “mémoires” confirming that the 20th century approach of prudential supervision and regulation of the financial world was no longer feasable given the volume and complexity of the 21st century financial world

    Two questions in this respect:
    – what is the consistency of Alan Greenspan’s alleged “unredeemable opaqueness” with “the most transparant capital markets” claimed by Mr.Dimon (and vice versa)
    – how does former Fed Governor Alan Greenspan explain and justify this unredeemable opaqueness, given his deliberate benign neglect, to say the least, as to proposals to enhance transparancy e.g. of the OTC -derivative markets formulated at the end of 1999 by Brooksley Born on the one hand and early warnings as to alarming developments in the sub-prime real estate credit area on the other hand.

  17. The sub-prime market holders were mislead, or trusted, on purpose, by those who had gotten out by 08. If anyone didn’t know it, was because no one told them, or they did not do their homework, or perhaps they live under a rock.

  18. As the European debt crisis worsens, additional infusions of cash, needed to add an additional layer to the patina of inter-connectedness, will only be just enough to provide the fees and bonuses to those financiers charged with keeping the system afloat. But like an ever-growing cancer, the blight will outstrip its food supply and drown in its own waste (metaphorically). The crash in Europe will crash a number of US banks. Too much opacity prevents us from being able to avert this crisis. Capitalism says let the weak fail. What does it say when we are all made weak by a financial cancer?

  19. Until the money supply stops growing, the cancer is surrounded by white blood cells and carried around like dead weight.

  20. It is abundantly clear that Congress and the Senate do nothing but extract $$$$ for themselves and their mass’ers 1% through tax policies. It’s disgusting to watch this greed.

    We the People have to get SERIOUS about this. They are supposed to be going back to their states for the recess. They need to be *contained­* in their state for crimes against We the People and not allowed to go back to D.C. to continue to steal EVERYTHING­.

    Send a person back to D.C. who is NOT a sociopathi­c liar thief and murderer working for Global Crime Inc.

    They can’t be allowed to get away with doing this ONE MORE TIME to over 100 million USA citizens – there aren’t enough drugs, force or propaganda that can keep the civil disobedien­ce from being kicked up a notch….h­ey, they’re always looking for a WAR – let’s give them a real one instead of being fleeced like sheep – they’re so sick with greed they’re finding ways to steal our skin and sell it for bio tech research in South Korea or somewhere – they will NEVER stop fleecing us from behind a *LAW*…..­so *ground* them in their districts – no phone tv or internet..­.

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