As part of the Dodd-Frank Act, the Volcker Rule (named after former Fed chair, Paul Volcker, who had proposed the rule as a way to avoid further economic downturn) establishes limits placed on bank funding and risky hedge fund investing. Remember the London Whale fiasco? Well, the Volcker Rule is supposed to stop that kind of nightmare from ever happening again. Or, at least, that’s the hope.
In a Wall Street Journal blog post from last week, Scott Patterson highlights the potential dangers in discerning the difference between proprietary trading and gambling on gigantic hedge funds. The issue is that regulators are seeking clear-cut instances and outlines in what they’re looking for in terms of targeting issues related to the Volcker Rule. This is all geared toward having rock-solid reference points once cases start hitting the courts.
"Financial institutions should not engage in unreasonable risk and regulators should not stifle investments essential to growing jobs and small businesses,” said Financial Services Roundtable CEO Tim Pawlenty. “The Volcker Rule issued today leans against striking that balance as it will reduce needed access to capital."
The Volcker Rule has faced harsh criticism from those concerned that increased regulatory coverage will hamper legitimate trades from being made, thus negatively impacting further economic recovery. In another WSJ piece, they ask what has taken so long to implement the Volcker Rule or something similar to it. The difficulty stems from what was previously stated, that legitimate trades bear a striking resemblance to illegal ones. If a trader short-sells a stock in order to make money off the decline, it’s not the easiest thing to uncover. Regulators are still struggling to put a legitimate definition on what they’re looking for in terms of legal and illegal.
The regulators aren’t the only ones struggling. Banks are still having issues when it comes to falling into compliance with a rule that doesn’t have an official definition. To simply state “Okay, we’re making this thing legit,” is drastically different than saying “Okay, we’re making this thing legit and here are the points of compliance that you’ll need to meet by 2015.”
This morning, multiple entities, including the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) had a hand in giving the Volcker Rule a thumbs-up or down.
“The final rule more clearly defines the types of trading activities that are exempt from the ban on proprietary trading. Perhaps the most challenging and complex of these exemptions has been the exemption for market making activities,” said FDIC Chairman Martin J. Gruenberg. “Under the final rule, the market making exemption has been updated to reduce operational complexity and uncertainty for banking entities and, at the same time, to increase management accountability for ensuring that the requirements of the exemption are met at all times.”
“This provision of the Dodd-Frank Act has the important objective of limiting excessive risk-taking by depository institutions and their affiliates,” said former Fed Chairman Ben S. Bernanke said in a statement via Bloomberg. “The ultimate effectiveness of the rule will depend importantly on supervisors, who will need to find the appropriate balance while providing feedback to the board on how the rule works in practice.”
Bloomberg’s Matt Levine wrote about his disdain for the Volcker Rule, stating: “Proprietary trading had basically nothing to do with the financial crisis, and banking is about taking ‘proprietary’ risk with depositor money. This is mostly called ‘lending,’ but calling it ‘lending’ doesn't make it safer than calling it ‘prop trading.’”
For more information on the Volcker Rule and whether or not it’s a good thing, check out the video here.