Volcker Rule
Encyclopedia
Paul Volcker
Paul Adolph Volcker, Jr. is an American economist. He was the Chairman of the Federal Reserve under United States Presidents Jimmy Carter and Ronald Reagan from August 1979 to August 1987. He is widely credited with ending the high levels of inflation seen in the United States in the 1970s and...
to restrict United States banks from making certain kinds of speculative
Speculation
In finance, speculation is a financial action that does not promise safety of the initial investment along with the return on the principal sum...
investments that do not benefit their customers. Volcker argued that such speculative activity played a key role in the financial crisis of 2007–2010. The rule is often referred to as a ban on proprietary trading
Proprietary trading
Proprietary trading occurs when a firm trades stocks, bonds, currencies, commodities, their derivatives, or other financial instruments, with the firm's own money as opposed to its customers' money, so as to make a profit for itself...
by commercial banks, whereby deposits are used to trade on the bank's personal accounts, although a number of exceptions to this ban were included in the Dodd-Frank law. The rule's provisions are scheduled to be implemented as a part of Dodd-Frank on July 21, 2012.
Background
Volcker was appointed by President Barack ObamaBarack Obama
Barack Hussein Obama II is the 44th and current President of the United States. He is the first African American to hold the office. Obama previously served as a United States Senator from Illinois, from January 2005 until he resigned following his victory in the 2008 presidential election.Born in...
as the chair of the President's Economic Recovery Advisory Board
President's Economic Recovery Advisory Board
The President’s Council on Jobs and Competitiveness, originally the President's Economic Recovery Advisory Board, is a panel of non-governmental experts from business, labor, academia and elsewhere that President of the United States Barack Obama created on February 6, 2009. The board reports...
on February 6, 2009. President Obama created the board to advise the Obama Administration on economic recovery matters. Volcker argued vigorously that since a functioning commercial banking system is essential to the stability of the entire financial system, for banks to engage in high-risk speculation created an unacceptable level of systemic risk. He also argued that the vast increase in the use of derivatives, designed to mitigate risk in the system, had produced exactly the opposite effect.
Proposal
The Volcker Rule was first publicly endorsed by President Obama on January 21, 2010. The proposal specifically prohibits a bank or institution that owns a bank from engaging in proprietary tradingProprietary trading
Proprietary trading occurs when a firm trades stocks, bonds, currencies, commodities, their derivatives, or other financial instruments, with the firm's own money as opposed to its customers' money, so as to make a profit for itself...
that isn't at the behest of its clients, and from owning or investing in a hedge fund or private equity fund, as well as limiting the liabilities that the largest banks could hold. Under discussion is the possibility of restrictions on the way market making activities are compensated; traders would be paid on the basis of the spread of the transactions rather than any profit that the trader made for the client.
On January 21, 2010, under the same initiative, President Obama announced his intention to end the mentality of "Too big to fail
Too Big to Fail
Too Big to Fail is a television drama film in the United States broadcast on HBO on May 23, 2011. It is based on the non-fiction book Too Big to Fail by Andrew Ross Sorkin. The TV film was directed by Curtis Hanson...
."
In a February 22, 2010 letter to The Wall Street Journal
The Wall Street Journal
The Wall Street Journal is an American English-language international daily newspaper. It is published in New York City by Dow Jones & Company, a division of News Corporation, along with the Asian and European editions of the Journal....
, five former Secretaries of the Treasury
United States Secretary of the Treasury
The Secretary of the Treasury of the United States is the head of the United States Department of the Treasury, which is concerned with financial and monetary matters, and, until 2003, also with some issues of national security and defense. This position in the Federal Government of the United...
endorsed The Volcker Rule proposals.
As of February 23, 2010, the US congress began to consider a weaker bill allowing federal regulators to restrict proprietary trading and hedge fund ownership by banks, but not prohibiting these activities altogether.
Senators Jeff Merkley
Jeff Merkley
Jeffrey Alan "Jeff" Merkley is the junior United States Senator from Oregon. A member of the Democratic Party, Merkley was a five-term member of the Oregon Legislative Assembly representing House District 47, located in eastern Multnomah County within the Portland city limits...
, Democrat of Oregon, and Carl Levin
Carl Levin
Carl Milton Levin is a Jewish-American United States Senator from Michigan, serving since 1979. He is the Chairman of the Senate Committee on Armed Services. He is a member of the Democratic Party....
, Democrat of Michigan, introduced the main piece of the Volcker Rule – its limitations on proprietary trading – as an amendment to the broader Dodd-Frank financial reform legislation that was passed by the U.S. Senate on May 20, 2010. Despite having wide support in the Senate, the amendment was never given a vote. When the Merkley-Levin Amendment was first brought to the floor, Senator Richard Shelby
Richard Shelby
Richard Craig Shelby is the senior U.S. Senator from Alabama. First elected to the Senate in 1986, he is the ranking member of the United States Senate Committee on Banking, Housing, and Urban Affairs and was its chairman from 2003 to 2007....
, Republican of Alabama, objected to a motion to vote on the amendment. Merkley and Levin responded by attaching the amendment to another amendment to the bill put forth by Senator Sam Brownback
Sam Brownback
Samuel Dale "Sam" Brownback is the 46th and current Governor of Kansas. A member of the Republican Party, he served as a U.S. Senator from Kansas from 1996 to 2011, and as a U.S. Representative for Kansas's 2nd congressional district from 1995 to 1996...
, Republican of Kansas. Shortly before it was due to be voted upon, Brownback withdrew his own amendment, thus killing the Merkley-Levin amendment and the Volcker Rule as part of the Senate bill.
Despite this vote, this proposal made it into the final legislation when the House-Senate conference committee passed a strengthened version of the rule that included the language prepared by Senators Merkley and Levin. The original Merkley-Levin amendment and the final legislation both covered more types of proprietary trading than the original rule proposed by the administration. It also banned conflict of interest trading. Senator Levin commented on the importance of that aspect: "We are also pleased that the conference report includes strong language to prevent the obscene conflicts of interest revealed in the Permanent Subcommittee on Investigations hearing with Goldman Sachs. This is an important victory for fairness for investors such as pension funds and for the integrity of the financial system. As the Goldman Sachs investigation showed, business as usual on Wall Street has for too long allowed banks to create instruments which are based on junky assets, then sell them to clients, and bet against their own clients by betting on their failure. The measure approved by the conferees ends that type of conflict which Wall Street has engaged in."
However, conferees changed the proprietary trading ban to allow banks to invest in hedge funds and private equity funds at the request of Senator Scott Brown
Scott Brown
Scott Brown is a United States senator.Scott Brown may also refer to:-Sportsmen:*Scott Brown , American college football coach of Kentucky State...
(R-Mass.), whose vote was needed in the Senate to pass the bill. Proprietary trading in Treasurys, bonds issued by government-backed entities like Fannie Mae and Freddie Mac, as well as municipal bonds is also exempted.
Since the passage of the Financial Reform Bill, many banks and financial firms have indicated that they don't expect The Volcker Rule to have a significant impact on their profits.
Implementation
Public comments to the Financial Services Oversight Council on how exactly the rule should be implemented were submitted through November 5, 2010. Financial firms such as Goldman SachsGoldman Sachs
The Goldman Sachs Group, Inc. is an American multinational bulge bracket investment banking and securities firm that engages in global investment banking, securities, investment management, and other financial services primarily with institutional clients...
, Bank of America
Bank of America
Bank of America Corporation, an American multinational banking and financial services corporation, is the second largest bank holding company in the United States by assets, and the fourth largest bank in the U.S. by market capitalization. The bank is headquartered in Charlotte, North Carolina...
, and JPMorgan Chase & Co.
JPMorgan Chase & Co.
JPMorgan Chase & Co. is an American multinational banking corporation of securities, investments and retail. It is the largest bank in the United States by assets and market capitalization.It is a major provider of financial services, with assets of $2 trillion and according to Forbes magazine is...
posted comments expressing concerns about the rule. Republican representatives to Congress have also expressed concern about the Volcker Rule, saying the rule's prohibitions may hamper the competitiveness of American banks in the global marketplace, and may seek to cut funding to the federal agencies responsible for its enforcement. Incoming Chairman of the House Financial Services Committee, Representative Spencer Bachus (R-Alabama), has stated that he is seeking to limit the impact of the Volcker Rule, although Volcker himself has stated that he expects backers of the rule to prevail over such critics.
Tom McMahon, head of the liberal lobbying group Americans for Progressive Change, responded to comments by Republican leaders by saying "It is truly astounding that less than a day after winning control of the people's House of Representatives, Republican leaders are already hard at work doing the business of big Wall Street banks."
Regulators presented a proposed form of the Volcker Rule for public comment on October 11, 2011, which was approved by the SEC, The Federal Reserve, The Office of the Comptroller of the Currency and the FDIC
Federal Deposit Insurance Corporation
The Federal Deposit Insurance Corporation is a United States government corporation created by the Glass–Steagall Act of 1933. It provides deposit insurance, which guarantees the safety of deposits in member banks, currently up to $250,000 per depositor per bank. , the FDIC insures deposits at...
. The proposed regulations were immediately criticized by banking groups as being too costly to implement, and by reform advocates for being weak and filled with loopholes.
Volcker himself stated that he would have preferred a simpler set of rules: “I’d write a much simpler bill. I’d love to see a four-page bill that bans proprietary trading and makes the board and chief executive responsible for compliance. And I’d have strong regulators. If the banks didn’t comply with the spirit of the bill, they’d go after them.”
Regulators have given the public until January 13, 2012 to comment on the proposed draft of the law. Under the Dodd-Frank financial reform bill, the regulations go into effect on July 21, 2012.
Historical antecedents
The Volcker Rule has been compared to, and contrasted with, the Glass–Steagall Act of 1933. Its core differences from the Glass–Steagall Act have been cited by scholars as being at the center of the rule's identified weaknesses.See also
- Dodd-Frank Wall Street Reform and Consumer Protection Act
- 2008–2010 bank failures in the United States
- 2008–2009 Keynesian resurgence2008–2009 Keynesian resurgenceIn 2008 and 2009, there was a resurgence of interest in Keynesian economics among policy makers in the world's industrialized economies. This has included discussions and implementation of economic policies in accordance with the recommendations made by John Maynard Keynes in response to the Great...
- Economic Recovery Advisory Board
- Financial crisis of 2007–2010
- Paul VolckerPaul VolckerPaul Adolph Volcker, Jr. is an American economist. He was the Chairman of the Federal Reserve under United States Presidents Jimmy Carter and Ronald Reagan from August 1979 to August 1987. He is widely credited with ending the high levels of inflation seen in the United States in the 1970s and...
- Too big to failToo Big to FailToo Big to Fail is a television drama film in the United States broadcast on HBO on May 23, 2011. It is based on the non-fiction book Too Big to Fail by Andrew Ross Sorkin. The TV film was directed by Curtis Hanson...
(economic term) - Glass-Steagall ActGlass-Steagall ActThe Banking Act of 1933, , was a law that established the Federal Deposit Insurance Corporation in the United States and introduced banking reforms, some of which were designed to control speculation. It is most commonly known as the Glass–Steagall Act, after its legislative sponsors, Senator...