Washington, D.C. — This May, the five financial regulators tasked with implementing the Volcker Rule issued a proposal that would severely undermine its effectiveness, stripping away many important protections included in the original 2013 final rule. A new Center for American Progress issue brief released today asserts that these Volcker Rule changes will introduce more risk into the banking system and financial markets just as policymakers are making the financial system less resilient through other regulatory and congressional actions.
“Before regulators finalize changes to the Volcker Rule that would increase the likelihood of another crash, they should carefully consider who pays for Wall Street’s highly risky activities when they go south,” said Gregg Gelzinis, research associate for economic policy at CAP and author of the brief. “Many Wall Street executives are wealthier today than they were before the crisis, while families across the country still carry the economic scars of a decade ago.”
If the proposal is finalized, banks will have far more leeway to engage in highly risky speculative trading activities. The proposed rewrite of the Volcker Rule would undermine the rule’s effectiveness in the following ways:
- Allows banks to govern their own market-making and underwriting limits. Banks would be allowed to formulate their own internal risk limits using calculations based on variables that they themselves would select. As long as banks stayed within the bounds of their own self-designed risk limits, regulators would assume full compliance with the reasonably expected near-term demand restriction on market-making and underwriting activities. Banks would not need prior approval from regulators to set and adjust their internal risk limits; they would simply be required to notify regulators of the limits and any changes.
- Opens the door to another London Whale. Before the 2013 Volcker Rule regulation was finalized, a massive $6 billion trading loss at JPMorgan Chase—known as the “London Whale” incident—was triggered by proprietary trading masked as hedging. Under the current Volcker rule, it is tougher for banks to game the hedging exemption when they have to document the specific exposures and demonstrate that, over time, their hedges are actually reducing risk through correlation analyses. The proposed rewrite would drop certain measures like the correlation analyses, which were put in place to mitigate the chances a bank could engage in speculative trading under the guise of hedging.
- Expands the liquidity management loophole. The 2013 Volcker Rule regulation included a carveout for trades executed for bona fide liquidity management purposes. Liquidity management refers to actions taken by a bank to ensure it has the appropriate assets to meet its expected cash and collateral needs across the firm. Transactions that fall within this carveout are not restricted by the Volcker Rule’s ban on proprietary trading. The carveout does not have any statutory basis in the Dodd-Frank Act and should be closed or restricted rather than maintained or expanded. Its scope and potential for risk are likely to be worsened by changes in the proposed rewrite, which expands the financial instruments eligible for the carveout.
- Eliminates foreign bank financing restriction. The Volcker Rule rewrite seeks to remove the foreign bank financing restriction, allowing the U.S. operations of foreign banks to fund the otherwise prohibited activities of their foreign parent or other subsidiaries. There is no financial stability upside to this change. This will simply allow the U.S. operations of foreign banks to gain exposure to activities that are prohibited by the Volcker Rule, importing more risk to U.S. shores.
- Weakens the definition of trading account. The Volcker Rule’s prohibition on proprietary trading applies to all trading conducted for a firm’s trading account. Any transactions that occur outside of the trading account fall outside of the scope of the Volcker Rule, which makes the definition of “trading account” crucial. The proposed changes to the rule would narrow this definition by likely placing fewer bank trading desks under active oversight by regulators, due to a new presumption of compliance for certain desks.
CAP’s brief was released in conjunction with a press call with the Americans for Financial Reform (AFR) Education Fund and Sen. Jeff Merkley (D-OR), who, along with former Sen. Carl Levin (D-MI), was a key congressional drafter and champion of the original Volcker Rule legislation in Dodd-Frank in 2010. The AFR Education Fund released its own report, “The Volcker Rule: Its Past, Present, and Uncertain Future,” which analyzes the origins of the Volcker Rule as a direct response to the Great Recession and assesses the long-term Wall Street effort to weaken the rule—an effort that may now be successful.
Click here to read “Hollowing Out the Volcker Rule” by Gregg Gelzinis.
Related resource: “Resisting Financial Deregulation” by Gregg Gelzinis, Andy Green, and Marc Jarsulic
For more information or to speak with an expert, contact Allison Preiss at [email protected] or 202.478.6331.