The Volcker Rule is a specific section of the Dodd–Frank Wall Street Reform and Consumer Protection Act originally proposed by American economist and former United States Federal Reserve Chairman Paul Volcker to restrict United States banks from making certain kinds of speculative 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 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.
I'm doubtful that the agencies will make that deadline. But I'm even more doubtful that this looming regulatory disaster will work.
One problem is that the "ban" will be riddled with many exemptions, permitting massive amounts of proprietary trading. For example, there's a new push to exempt venture capital financing from the Volcker Rule:
In a letter to the SEC, Representative Bob Goodlatte (R-VA) urged that the final regulations implementing the Dodd-Frank Volcker Rule provisions exempt venture capital funds or provide that they are a permitted activity under Section (d)(I)(J). ... Venture capital investing helps startup companies around the country create jobs, build products, invest in research and development and generate life-changing solutions in fields like energy and life sciences, he posited. Further, the venture ecosystem is one of the bright spots in the U.S. economy. In 2010, venture-backed companies employed 11.9 million people and generated $3.1 trillion in revenues. Therefore, the legislator emphasized that it is vital that the final regulations do not create an unnecessary barrier to future venture investing, especially because it does not carry the risks the Volcker Rule aimed to limit.
There will be many more of these sort of exemptions in the final rule. What will follow is likely to be years of regulatory rule making and litigation over whether certain activities qualify for one of those exemptions. The so-called ban likely will suffer the slow death of a thousand cuts.
On top of which, there will be years of work entailed in dealing with all the unitended consequences and unanticipated problems that are inevitable in such a complex regulatory scheme. Consider, for example, the new complaint that the Volcker Rule violates NAFTA:
The Volcker Rule may contravene the NAFT A trade agreement, said the Canadian investment industry, since it will clearly interfere with and raise the costs of cross-border dealing in Canadian securities. In a letter to the SEC and other federal financial regulators crafting regulations implementing the Dodd-Frank Volcker Rule provisions, the Investment Industry Association of Canada said that the Volcker Rule also runs counter to G20 and Financial Stability Board objectives for coordinated policymaking across jurisdictions. The association urged the SEC to extend the proposed exemption from the proprietary trading prohibitions for U.S. Treasury bonds and U.S. state and municipal bonds to foreign government securities, particularly to the securities of Canadian federal and provincial governments.
Inevitably, people are going to find more and more of these sort of conflicts between the Volcker Rule and other laws, especially but not only in the context of the Rule's extra-territorial effects.
I was prepared to support the original Volcker rule as an imperfect solution to the moral hazard inherently created by deposit insurance.
Unfortunately, the process of turning the simple original proposal into law has turned into a classic example of legislative and regulatory sausage making. The end product is shaping up to be an unpalatable mess.
Update: My friend Kim Krawiec writes about this post that:
A recent post by my friend Steve Bainbridge reminds me that I’ve been meaning to weigh in on the most recent in a long line of controversies surrounding the Volcker rule ....
I’m largely on board with Steve’s general analysis of the rule, but I want to push back against his contention that regulators have taken Congress’s simple ban and turned it into an unworkable monstrosity at the behest of relentless industry lobbying. This charge has been taken up by a number of sources lately (see here and here), including by some self-serving members of Congress.
Let’s get one thing straight: Congress did not enact a simple rule – it enacted a short rule. By definition, a rule that purports to ban proprietary trading while maintaining an active role for banks as financial market intermediaries, including as market makers, is not a simple rule.
If this post in fact implies that "regulators have taken Congress’s simple ban and turned it into an unworkable monstrosity," it was not my intent to have you readers draw that inference. (1) My reference to the "original Volcker rule" linked back to a post discussing Paul Volcker's original suggestion, not the version incorporated into Dodd-Frank. (2) I noted that "the process of turning the simple original proposal into law has turned into a classic example of legislative and regulatory sausage making." I thus had no intention of complimenting Congress for its work in Dodd-Frank. To the contrary, I intended to suggest that both Congress and the regulators were at fault. Indeed, I've agreed all along with Kim's observation that the regulatory mess was "predictable, indeed virtually inevitable, given the original statute." Of course, having said that, the regulators have not distinguished themselves in the process of turning the flawed statute into regulatory specifics.