Today, 3 1/2 years after President Barack Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act, five (count 'em, five) federal regulatory agencies finally will get around to voting on one of its cornerstone provisions: the so-called "Volcker Rule."
The rule will ban banks from "proprietary trading," that is, making certain risky bets with the banks' own money, bets that return huge rewards to bank executives and shareholders when they pan out, but which taxpayers might have to cover if they don't.
The Volcker Rule — the brainchild of Paul Volcker, chairman of the Federal Reserve under Presidents Jimmy Carter and Ronald Reagan — is vital to reducing risks in banks judged "too big to fail." Among them: JPMorgan Chase, Citigroup, Bank of America, Goldman Sachs and Morgan Stanley.
Had a version of the Volcker Rule been in effect in the mid-2000s, many of the worst effects of the 2008 financial crisis would have been mitigated. Not all of the losses that crashed the financial and mortgage markets can be blamed on proprietary trading, but many can. Had the rule been in effect in 2011-2012, most of the $6 billion in losses caused by JPMorgan Chase's "London Whale" would have been averted.
The Volcker Rule is a very good idea that has taken far too long to implement. The reason for that is a case study of Washington at its worst.
Since Congress passed Dodd-Frank in June 2010, both Dodd and Frank have left. Former Sen. Christopher Dodd, D-Conn., is now the $2.4 million-a-year chief lobbyist for the movie industry. Former Rep. Barney Frank, D-Mass., who retired in January, has resisted the revolving door.
But nearly everyone they fought against is still in place. Lobbying against the Volcker Rule has become a full-time job for hundreds of lobbyists and lawyers. The Center for Responsive Politics reports that finance firms and trade associations spent $96.8 million during 2012.
Understandably so. In 2011, the Government Accountability Office estimated proprietary trading divisions at the six biggest banks generated $15.6 billion from 2006 to 2010. Banks have complained that they'll spend $1 billion a year just complying with the rule, assuming the rule says what they think it's going to say.
The rule is expected to be complex in large part because banks have made it so. Some forms of proprietary trading may still be legal. Those would be so-called "market-making" trades, in which banks match buyers and sellers. The rule is expected to allow normal hedging trades to balance risk. The trick will be telling which trades are made in pursuit of profit and which are made as middlemen in a deal or to offset risk.
One key to judging the effect of the rule to be voted on today is how narrowly the government chooses to define "hedging." For example, back in March, JPMorgan's CEO, Jamie Dimon, argued that even the $6 billion trading loss incurred by his firm's Bruno Iksil — the infamous London Whale — was caused merely by "portfolio hedging."
Mr. Dimon in effect was arguing that any trade could be regarded as a hedge because it was intended to make money, thus offsetting any potential trade that might lose money. The usual definition of a hedge is a trade made to balance an existing risk, not a hypothetical one.
Even if the rule-making agencies today create a strong Volcker Rule, it won't go into effect until mid-2015. Banks reportedly are planning legal challenges. Their favorite anti-regulatory litigator is Eugene Scalia of the Washington firm Gibson Dunn LLC. His father is a Supreme Court justice. Washington is a very small town.
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