Editorial Board

Simplify the Volcker Rule; Don’t Weaken It

Focus on outcomes instead of trying to get into traders’ heads.

What’s he thinking?

Photographer: Eric Piermont/AFP/Getty Images

The Trump administration is drawing up a proposal to simplify the Volcker Rule, one of the most controversial pieces of the 2010 Dodd-Frank financial reform. This could be a desirable development, as long as it doesn’t weaken a crucial safeguard against gambling with taxpayers’ money.

The Volcker Rule has a worthy goal: Limit government subsidies to financial institutions. When authorities bailed out banks during the 2008 crisis, they found themselves propping up activities — including outright bets on securities and derivatives — that had little to do with providing credit. To narrow the scope of what taxpayers support, the rule largely prohibits deposit-taking institutions from speculating.

Congress, however, left regulators to define what speculating, or “proprietary trading,” actually meant. This was particularly difficult because legislators also agreed to exempt two activities hard to distinguish from it: market-making and hedging. Both involve buying and selling securities and derivatives, in the first case on behalf of customers, in the second to mitigate risks.

Regulators tried to put the burden of proof on the banks. Positions held for less than 60 days are presumed to be proprietary trading unless banks can prove otherwise, in part by producing a slew of trading metrics. The idea was that examiners would eventually learn to divine traders’ intentions from the data. But they haven’t. Worse, each agency can interpret the data in its own way — and a single bank might report to as many as five. It’s a mess.

The various regulators — the Federal Reserve, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency, the Securities and Exchange Commission, and the Commodity Futures Trading Commission — are close to proposing changes. Bloomberg has reported that they’re planning to drop the 60-day presumption, allowing banks more leeway to decide how to comply with the spirit of the law.

This could make sense, but not if it leaves the basic question — what is speculation? — unanswered. Banks still won't be sure how to comply. And taxpayers could find themselves back in the business of subsidizing proprietary trading.

A better way might be to focus on outcomes, not intent. Speculative trading differs from market making and hedging in seeking to profit from price movements. That makes it prone to big gains and losses. Setting a conservative threshold for volatility, typically lower than that of the broader market for the relevant assets, would draw a bright line. Breach it, and you’d have to explain yourself.

Granted, some speculative activity might slip through, just as now. But the key thing is to limit risk to taxpayers while lifting the burden of reporting and compliance, which this would do. The stringency of the rule would depend on where regulators set the threshold: Done right, simpler could even be stronger.

    —Editors: Mark Whitehouse, Clive Crook.

    To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net .

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