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Paul Volcker: In His Own Words

February 14, 2012
He may not have gotten in the last word –with over 14,000 comments submitted to the SEC alone, it would have been hard – but he did get in his two cents.

Photo by epicharmus. Some rights reserved.

Paul Volcker, the inspiration behind the eponymous “Volcker Rule,” sent an eight-page letter to the federal regulators responsible for implementing the Dodd-Frank Act’s prohibition against proprietary trading. Eight-pages, compared to GE’s 37, the International Swaps and Derivatives Association’s 24, and the 154-page tome jointly submitted by the Securities Industry and Financial Markets Association, the American Bankers Association, the Financial Services Roundtable and The Clearing House Association. The proposed rule itself is almost 300 pages.

Mr. Volcker’s comments are succinct and to the point. To the various objections raised in response to the Act’s prohibition he has a two-word response: “not so.”

He groups the objections into four categories: (1) proprietary trading by commercial banks is not an important risk factor; (2) needed liquidity in trading markets will be imperiled; (3) the competitive position of U.S. based commercial banking institutions will be adversely affected; and (4) the proposed regulation is simply too complicated and costly. He addresses each in turn.

Risk. Proprietary trading is inherently speculative and, therefore, risky by definition. The failure of investment banks’ internal controls to identify those risks led them to either merge with commercial banks or obtain a banking license from the Federal Reserve. They did so for the express purpose of obtaining federal government support. Mr. Volcker reminds regulators that the handful of institutions which will most be affected by the prohibition have a choice: “give up either their proprietary trading activity or their banking license. The apparent reluctance to do the latter only reinforces the perceived value of access to the Federal safety net and the substantial implicit subsidy to borrowing costs.”

Liquidity. Mr. Volcker questions the accepted wisdom which says that ever-increasing amounts of liquidity are good. A growing number of economists believe that after a certain point, the marginal utility of liquidity diminishes.

Competition. “The argument that United States banking organizations will suffer in their competitive position vis-à-vis international banks seems superficial at best, and more likely proprietary trading is counter to their prospects. . . . Any contribution of proprietary trading to customer service and competition is not at all obvious. In fact, because of the risks, the conflicts of interest and the adverse cultural influence it may well impede effective competition.”

Complexity. “The complexity and potential cost[] of any rule-making in the world of modern finance presents a challenge. Enforcement of the restrictions required by the Volcker Rule is no exception. In approaching this problem, let us not lose sight of the fact that existing risk management practices of large financial institutions here and abroad, including some major U.S. commercial banks, fundamentally failed, at great cost to financial stability and the world economy.”

View the full-text of Paul Volcker’s comments here.

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