THE VOLCKER RULE IS A GIFT TO BANKS AND EXCLUDES THE REST / THE FINANCIAL TIMES COMMENT & ANALYSIS

December 13, 2013 6:45 pm

The Volcker rule is a gift to banks and excludes the rest

Christopher Caldwell

Only an obsessive could develop the mastery to enforce or evade this law

Three years ago, the US Congress set out to deliver a blunt message to the finance industry that enough was enough. The Volcker rule – named after, though not drafted by, respected former Federal Reserve chairman Paul Volcker – was supposed to prevent the recurrence of one of the more disreputable practices blamed for the finance crisis of 2008.

Banks would no longer be able to take deposits guaranteed by the US taxpayer and use them to speculate for their own gain. Embedded in the larger Dodd-Frank finance reform, the Volcker rule was presented to the public as the modern equivalent of the Banking Act of 1933 (known as Glass-Steagall), parts of which were recklessly repealed in 1998. But it is no such thing. It is too complex for that. Congress has done small savers and taxpayers no favours and has probably delivered a gift to the larger banks.

The Volcker rule is supposed to be Glass-Steagall updated for a more complex time. Just how much more complex was revealed this week, when the five agencies that are to administer the rule released the final text. The entire 1933 act, which ordered the US banking industry without mishap for the better part of a tumultuous century, is 37 pages long. The principles people mean to invoke when they say “Glass-Steagall” cover a few dozen words of the act, and a child could give you the gist: banks cannot deal in securities; securities companies cannot accept deposits; and banks and securities companies cannot have interlocking directorates.

The Dodd-Frank act, by contrast, is 828 pages long. It calls for 398 separate “rulemakings”, which so far run to 14,000 pages. The most ballyhooed is the Volcker rule, which is due to come into effect in 2015. An 882-page “preamble” purports to explain it but ambiguities remain. Short-term speculative proprietary positions are off limits. Banks can engage in underwriting and market-making (acquiring financial instruments their customers have a standing need for), as long as it is “designed not to exceed the reasonably expected near-term demands of customers”.

They can hedge their market bets, too, but a hedge must be something “that is designed to reduce, and demonstrably reduces or significantly mitigates, specific, identifiable risks” and it must be constantly recalibrated. Part of the bill’s intricacy comes from the impossibility of demarcating “speculation” from “hedging” and “market-making” in a foolproof way.

But they must be demarcated. That means discretion for regulators; this discretion means “partnership” between government and the commanding heights of the financial industry. Under the rule, banks will draw up the “compliance plans” to which they are to be held. How this works will depend on who runs Washington, but there will be perverse incentives. When the regulation to be complied with is an 882-page rider (Volcker Attachment B) to an 828-page bill slated to generate a stack of “rulemakings” 10ft high, we are not talking about regulators so much as exegetes. A law like that makes such demands on one’s understanding that only an obsessive or a monk could develop the mastery to enforce or evade it. No influence-peddling will be needed to produce what the economist George Stigler called “regulatory capture”. Regulator and banker will share an ethos, a language and a folklore.

Bankers will have to walk regulators through their plans and positions. Something that looks strange and suspicious could be a brilliant new hedging strategy. Any regulator who masters the law’s applications to company Y’s portfolio will become a desirable hire for company Z’s trading desk. Over time, all participants in investment banking and investment oversight will know each other’s secrets – totally arcane to the rest of society – and rotate in and out of government and business. Already in the past half-decade, a small cast of bankers and senior policy makers have traded places without friction: Hank Paulson and Tim Geithner in the US; Mario Monti and Mario Draghi in Europe.

Complexity is regressive. While the Volcker rule exposes big bankers to various regulatory sanctions, it actually shelters them from something more threatening: the kind of democratic scrutiny Glass-Steagall brought. A striking thing about Walter Bagehot’s 19th-century classic Lombard Street is the book’s defence of some of the inefficient-looking aspects of banking. The short hours bankers work and the high compensation they receive for not particularly difficult work were, to Bagehot, tokens of their reliability and transparency. He would have viewed the contrast between the certitudes of Glass-Steagall and the ambiguities of Volcker as reflecting poorly on the newer legislation. “The business of banking ought to be simple,” he wrote. “If it is hard it is wrong.”


The writer is a senior editor at The Weekly Standard

Copyright The Financial Times Limited 2013