An Even Weaker Volcker Rule

A recent New York Times editorial contends that the Dodd-Frank’s Volcker rule, which limits banks from engaging in speculative and risky proprietary trading, is in jeopardy of being further eviscerated. In late 2011, after consistent lobbying from the banking industry, regulators have now proposed rules that open the door for the industry to further remove the remaining teeth from the rule.

Per the New York Times op-ed: "The banks hate the rule because less speculation means less profit and lower bonuses for traders and bank executives. And ever since it was signed into law in mid-2010, they have pressed Congress and regulators to weaken it. Sure enough, in late 2011, regulators issued proposed rules that are ambiguously worded and lack the teeth to rein in the banks. Paul Volcker — the former chairman of the Federal Reserve for whom the rule was named — and other reformers have rightly urged significant changes before the rule becomes final in mid-July. Regulators need to listen."

The opinion piece argues for greater specificity in the language of the rule. For example, the proposed rules do not adequately specify between "non-proprietary trading" and "proprietary trading." The Times specifies that because banks should "continue to serve customers, the law instructs regulators to allow certain forms of nonproprietary trading, including 'market making,' in which banks can buy and sell securities, but only for the purpose of facilitating transactions for clients. The proposed regulations fail to adequately distinguish between the two types of trades. That could allow banks to engage in proprietary trades under the guise of market making."

Further, the Times advocates for additional bans of the type of trading that led to the mortgage meltdown of 2008. "To limit speculation, the proposed regulations advise banks to avoid short-term trading. But they fail to specifically ban broader trading strategies, like the high-frequency trading that was implicated in the infamous flash crash of 2010 and that has become a profitable source of banks’ proprietary trading."

Finally, the op-ed argues for firmly defined penalties. "The proposed regulations lack clear, stiff penalties, beyond threats that banks found to be engaged in proprietary trading will be forced to stop. They also need to clearly define and punish conflicts of interest that arise when banks cross the line into proprietary trading while at the same time purporting to serve as a middleman for clients."

With the banking industry lobbying aggressively for the ability to continue to engage in proprietary trading, the Volcker Rule continues to stand at a precipice. Already watered down prior to passage in Dodd-Frank, it remains to be seen whether the Volcker Rule will have any gravity at all once the rules are approved.