Bankers’ Objections to Volcker Rule Fail on the Merits: View
Big U.S. banks have found a lot not to like in the Volcker rule. We agree that regulations shouldn’t be unduly burdensome. But we see no good reason to share banks’ objections on this one.
The rule, mandated in the Dodd-Frank Act and named after former Federal Reserve Chairman Paul Volcker, is supposed to bar federally insured banks from making speculative bets for their own account -- the kind of proprietary trading that generates juicy profits and bonuses in good times, but can lead to heavy losses in bad times. The idea is that if traders want to take big risks, they should do it outside deposit-taking institutions that enjoy the explicit backing of U.S. taxpayers.
Regulators recently proposed a version of the rule that, while imperfect, hews close to the intent of Dodd-Frank and seeks to narrow loopholes. Given the criticism the proposal has already faced -- including from JPMorgan Chase Chief Executive Officer Jamie Dimon, who said it could put U.S. companies at a “huge disadvantage” -- we thought it would be helpful to address the main objections on the merits.
The complexity is largely financial-industry lobbyists’ own doing. They have argued that a proprietary trading ban would hinder market making, in which banks facilitate customers’ trades, and underwriting, in which banks help their clients issue new stocks and bonds. As a result, many of the proposed rule’s 298 pages and 383 questions are devoted to carving out exceptions for such activities that won’t create huge loopholes for banks to exploit.
If banks would prefer a simpler rule, why not return to the Glass-Steagall Act? In about a page, the 1933 law largely limited banks to taking deposits and making loans. Other firms handled market making and underwriting perfectly well before the law’s 1999 repeal.
Otherwise, yes, banks that want to manage different businesses under one roof might have to handle a little complexity. It’s worth noting that the typical mortgage bond prospectus runs into the hundreds of pages. The final Volcker rule will probably be shorter than that.
Only 25 of the largest U.S. banks will face significantly larger compliance costs, according to a by Bloomberg Government. What’s more, those banks could avoid most costs if they spun off their trading and underwriting activities, a move for which the rule’s two-year transition period provides ample accommodation. The remaining 995 U.S. bank holding companies won’t have to comply with the Volcker rule’s more onerous reporting requirements, because their trading assets fall below a threshold of $1 billion.
True. But once the crisis started, trading losses made it a lot worse. Proprietary trades gone bad took a $15.8 billion bite out of the capital of the six largest U.S. banks during the darkest days of 2007 and 2008, according to the Government Accountability Office. Because banks typically lend or invest about $10 for every $1 in capital, the losses probably reduced the available credit in the economy by roughly $160 billion.
Combining the mundane business of taking deposits and making loans with high-stakes proprietary trading also complicates bailouts. As the growing Occupy Wall Street protests illustrate, bailing out institutions that pay huge bonuses to traders and executives doesn’t sit well with the public. There’s nothing inherently wrong with big compensation packages, as long as they’re not at taxpayer expense.
There’s little evidence to support this, and it’s entirely possible that the benefit of avoiding credit-sapping trading losses will outweigh any compliance costs.
If banks insist on maintaining trading activities, the industry will spend an aggregate 4.8 million hours setting up compliance operations, and an additional 1.8 million hours a year on reporting, regulators estimate. At a generous $500 an hour, that comes to $2.4 billion initially and $900 million a year beyond that. The recurring cost represents about 1 percent of credit institutions’ average annual pretax profits as measured by the Commerce Department.
On the upside, if commercial banks are more resilient, financial crises will be less likely to trigger recessions, and banks will be able to keep lending precisely when the economy needs it most. Although hard to quantify, these benefits are likely to be very large.
Traders within commercial banks have enjoyed an unfair advantage, because the institutions’ federal backing gives them access to cheap money. If U.S. taxpayers stop subsidizing proprietary trading in this way, they will level the playing field. That could actually improve the competitive position of hedge funds, securities dealers and other firms that aren’t federally insured.
True, big U.S. banks might find it harder to compete with foreign institutions whose traders still enjoy taxpayer support. But that’s not a very good argument against the rule. The multi-billion-dollar losses of rogue traders, such as Jerome Kerviel at French bank Societe Generale SA and Kweku Adoboli at Swiss bank UBS Ltd., suggest the Europeans should be following the U.S., not the other way around. U.S. regulators should also maintain a clause in the proposed rule that forbids banks to design trader pay in ways that reward risk-taking.
Hallelujah. That’s exactly where it should be. Of course, as the bankruptcy of Lehman Brothers Holdings Inc. and the demise of Long-Term Capital Management LP have demonstrated, financial institutions besides banks can threaten the system, too. Regulators are working out criteria to identify the dangerous ones, and Dodd-Frank allows the Fed to impose tougher rules on them.
Just about any reform creates winners and losers. In the year ended July 2011, financial industry representatives held 265 meetings with federal agencies about the rule, compared with only 18 meetings for groups that could have provided a counterweight, according to research by Duke University law professor Kimberly Krawiec. The fact that the rule has survived this far is a testament to its fundamental wisdom. May the merits prevail.
To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at email@example.com.