Economics / Finance

The Uncertain Future of the Volcker Rule

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The Volcker Rule is a possible target of President-Elect Trump’s administration. Image Source: Michael Vadon

Dismantling the Dodd-Frank Act is one of president-elect Donald Trump’s campaign promises. Written in response to the Financial Crisis of 2008, the Dodd-Frank Act is a sprawling financial reform legislation aimed at improving the stability of our financial system. A key component of the act, the Volcker Rule, faces demise under the new administration.

The Volcker Rule prevents commercial banks from making speculative investments with proprietary funds. Paul Volcker, the chairman of Obama’s Economic Recovery Advisory Board, believes that commercial banks, enjoying government support and protection, owe “an element of fiduciary responsibility” to taxpayers and should not engage in proprietary trading as such activities create risks without benefiting the customer. [1] According to Investopedia, proprietary trading occurs “when a firm or bank invests for its own direct gain instead of earning commission dollars by trading on behalf of its clients.” [2] The problem lies in distinguishing proprietary trading from acceptable market-making activities. What constitutes investing for “own direct gain” and not “trading on behalf of clients”? Vague regulation can leave loopholes through which banks continue to engage in risky behavior, while specifying individual cases can take up thousands of pages and impose excessive compliance costs. Multi-agency jurisdiction, industry lobbying, and partisan politics further complicates the process. In the case of the Volcker Rule, three years of legislative wrangling resulted in 964 pages of regulation fraught with footnotes and exemptions.

Steve Mnuchin, Treasury Secretary nominee under Donald Trump, claims that the Volcker Rule is “too complicated and people don’t know how to interpret it”. [3] Similar critics believe that the Volcker Rule is an ineffective regulation due to the difficulty of defining proprietary trades and alternative ways to regulate trading should be introduced. [4] The Heritage Foundation, a conservative think tank, argues that proprietary trading should not be the target for regulation. Instead it suggests replacing the rule with “simpler and higher capital requirements” because the ban on proprietary trading restricts market makers from providing liquidity and increases risks instead. [5] Corporations from various industries have echoed fears of liquidity drying up. [6] Rep. Jeb Hensarling (R-TX) recently proposed the Financial CHOICE Act to scale back Dodd-Frank, which includes repealing the Volcker Rule and providing regulatory relief for banks that maintain high levels of capital. The Trump administration has yet to announce an official plan of action regarding the Volcker Rule.

“Liquidity is in the mind of the beholder”, says Volcker in response to the banking industry’s concerns. [7] Before the crisis, commercial banks had complete access to their clients’ assets and enjoyed extra income by investing them in riskier ways. Banks have an incentive to demonstrate the rule’s shortcomings. While even Dodd-Frank supporters might agree that the rule could be less complicated and costly for smaller banks, attempts to dismantle the Volcker Rule completely will surely meet heavy resistance.

Given Dodd-Frank’s universal impact, lobbyists, ideological think tanks, and political factions are likely to be just as involved as academia in assessing its effectiveness. Whether the Volcker Rule should be staying in its current state, reformed, or repealed is an ongoing debate between economists, politicians, and businesses. Regardless of what happens to the rule next year, it seems certain that this debate will continue long after Trump’s presidency.

Sources:

1) P. Volcker, “Financial Reform: Unfinished Business,” 24 November 2011. [Online]. Available: http://www.nybooks.com/articles/2011/11/24/financial-reform-unfinished-business/. [Accessed 5 December 2016].
2) Proprietary Trading, Investopedia, LLC., 2016.
3) J. M. Schlesinger, “Trump Treasury Choice Steven Mnuchin Vows to ‘Strip Back’ Dodd-Frank,” 30 November 2016. [Online]. Available: http://www.wsj.com/articles/trump-treasury-choice-steven-mnuchin-vows-to-strip-back-dodd-frank-1480513188. [Accessed 7 December 2016].
4) R. R. Chatterjee, “Dictionaries Fail: The Volcker Rule’s Reliance on Definitions Renders it Ineffective and a New Solution is Needed to Adequately Regulate Proprietary Trading,” Brigham Young University International Law and Management Review, vol. 8, no. 1, pp. 33-62, 2011.
5) S. M. Miller and J. W. Verret, “No Need for Title VI with Simpler, Higher Capital,” The Case Against Dodd–Frank: How the “Consumer Protection” Law Endangers Americans, p. 127, 2016.
6) B. Protless, “The Volcker Rule’s Unusual Critics,” 15 Feburary 2912. [Online]. Available: http://dealbook.nytimes.com/2012/02/15/the-volcker-rules-unusual-critics/. [Accessed 7 December 2016].
7) P. Volcker, Interviewee, Liquidity Is In Mind of Beholder, Volcker Says. [Interview]. 18 October 2016.
8) G. T. Rubin, “Biden Defends Dodd-Frank, Other Obama Financial-Regulation Policies,” The Wall Street Journal, 5 December 2016. [Online]. Available: http://www.wsj.com/articles/biden-defends-dodd-frank-other-obama-financial-regulation-policies-1480975072. [Accessed 7 December 2016].

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