After three years, multiple missed deadlines, and at least 111 meetings between regulators and Wall Street groups (versus only eighteen meetings with pro-reform groups), we finally have a final version of the Volcker Rule—and if properly enforced, it will change the business of banking for the better.
The Volcker Rule aims to ensure that banks that enjoy the backing of the federal government and the cushion of customer deposits do not get to make risky bets (or, in the language of the rule, “proprietary trades”). In other words, banks that have a taxpayer-provided parachute don’t get to BASE jump off of mountains for the thrill (and profit) of it.
It was a long path to get here: Senators Jeff Merkley and Carl Levin authored the law in 2010, as a part of the Dodd-Frank Act. Financial regulators were responsible for writing the final rule. A draft was published in 2011, and 18,000 comment letters were written, the vast majority by Wall Street interests. But reformers also wrote letters, including Americans for Financial Reform, Better Markets, Public Citizen and a letter from the group “Occupy the SEC” that I co-authored. Despite being vastly outnumbered, reformers made a real difference: the final rule rejected many of the additional exemptions banks wanted, and it is stronger than the draft in many key places.
Win: No Portfolio Hedging
In the original law, Congress sought to preserve banks’ ability to trade with clients (called “market making” on Wall Street), as well as their ability to hedge their risk, which is the way banks try to protect themselves from staggering losses. But many feared these allowances for market making and hedging could be abused. As I previously pointed out in The Nation, the London Whale trading fiasco highlighted an enormous loophole in the rule for “portfolio hedging.” This blanket loophole could have allowed banks to continue their proprietary trading unimpeded.
Not only is portfolio hedging gone, the hedging exemption overall has been significantly strengthened. Banks now have to outline ahead of time specifically what kinds of trades would be appropriate hedges and show that they demonstrably reduce risk—an extremely positive step.
For these improvements, we undoubtedly owe a debt of thanks to new SEC Commissioner Kara Stein—who insisted that the hedging exemption was too broad—and to CFTC commissioners Gary Gensler and Bart Chilton who also advocated for strengthening this provision. Without their efforts, this rule would undoubtedly have been weaker.