The Volcker Rule

Paul Volcker is a man of considerable stature, and not just because he’s six feet, seven inches tall. He gained a reputation for courage and plain talk as chairman of the Federal Reserve System under Presidents Carter and Reagan because he broke the back of the 1970s inflation. He did so by (mostly) sticking to a tight monetary policy even though that meant sky-high interest rates and sharp back-to-back recessions before the economy could enter its vigorous recovery. Now 84, he has enjoyed a comeback in recent years as an adviser to President Obama. His Volcker Rule, prohibiting proprietary trading by banks, was heralded as one way of preventing a repeat of the recent financial crisis, and it became part of the Dodd-Frank Act signed into law in July 2010.

Dodd-Frank’s full title, incidentally, is the Wall Street Reform and Consumer Protection Act. Like most current legislation its name reflects hoped-for outcomes, not its actual provisions. Reading the act (the PDF is available here) is not for the faint of heart. There are 16 titles consisting of 1,601 sections for a total of 848 dense pages. Only a lawyer could love sentences like this:

Any nonbank financial company supervised by the Board that engages in proprietary trading or takes or retains any equity, partnership, or other ownership interest in or sponsors a hedge fund or a private equity fund shall be subject, by rule, as provided in subsection (b)(2), to additional capital requirements for and additional quantitative limits with regards to such proprietary trading and taking or retaining any equity, partnership, or other ownership interest in or sponsorship of a hedge fund or a private equity fund, except that permitted activities as described in subsection (d) shall not be subject to the additional capital and additional quantitative limits except as provided in subsection (d)(3), as if the nonbank financial company supervised by the Board were a banking entity.

Volcker initially outlined his proposal in a three-page memorandum. It came to life as Section 619 of Dodd-Frank, expanded to 11 dense pages. This section is supposed to prevent banks from buying and selling securities for their own accounts, in contrast to brokering customer trades. It also prohibits banks from holding interests in hedge funds or private equity funds or from sponsoring such funds. These prohibitions are supposed to lessen the need for future bailouts like those that were provided to financial institutions in 2008 and 2009. Continue reading