Is the Volcker Rule too Soft on Wall Street?

Banks appear to breathing a collective sigh of relief after the approval of the Volcker Rule yesterday. Is that a sign that the rule is too light?

After three years of anxiety and apocalyptic talk about how the rule would have a crippling impact on the industry—as well as an unprecedented amount of Wall Street lobbying of regulators involved in writing the legislation—the consensus is that the final rule is far less dire than bankers feared. In other words, some of that lobbying may have worked.

The element that Wall Street executives were arguably most concerned about—their ability to continue lucrative market-making trading activities—was largely preserved as regulators carved out an exemption for it. This is one of the fuzziest areas of the new rules, and one of the greatest potential sources of abuse: The difference between the purchase of stocks or bonds because a customer might want to trade them and because the bank itself might like to trade them isn’t always clear. The banks will be required to try to distinguish between the two and to compensate traders according to their satisfaction of customer demand, rather than on proprietary profits.

New requirements surround hedging—a term meant to refer to trades that offset specific risk, but that has come to mean a general umbrella referring to pretty much anything (such as the London Whale’s positions at JPMorgan Chase). Now banks will have to be more specific about what their hedges are hedging. In short: Paperwork requirements will definitely increase, but Wall Street firms will probably continue much of the profit-amplifying trading they’ve become so hooked on.

Paul Volcker, chairman of the U.S. Federal Reserve from 1979 to 1987, came up with the idea for the rule in 2009 after the financial crisis struck, arguing that deposit-taking banks backed by the government shouldn’t engage in speculative proprietary trading. It became a central element of the 2010 Dodd-Frank financial reform legislation and was subjected to some of the most ardent debate. The rule was finally approved yesterday by five federal agencies: the Fed, the Federal Deposit Insurance Corp., the U.S. Securities and Exchange Commission, the Office of the Comptroller of the Currency, and the U.S. Commodity Futures Trading Commission. It was supposed to go into effect on April 1, but the Fed granted an extension until July 2015 for banks to comply. The industry has already indicated that it plans to continue fighting the rule, including challenges in court.

“I talked to the regulators today,” Volcker said in an interview with Bloomberg News. “They’ve done a good job of balancing. You can either regulate by rule or by principle. This regulation attempts to do both.”

“You probably have read the rule more than I have,” he added. “It’s complicated, but I was gratified to see that the rule itself is shorter than my own home insurance policy.”

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